Updated: Jan 20, 2020
With the month of October taking it's toll on stocks, an uneasy feeling generally sets in for most investors. Some studies say that people are 2-3 times more sensitive to losses than they are gains. So what do people do? Some go to cash. Some go to bonds because they think they're safe. Some try to time the market. Finally, the smallest percentage of people, understand that corrections are a part of investing, and although they're not thrilled to experience them, they don't make rash decisions when their goals and risk tolerance haven't changed.
Going to Cash
Over the past couple of months I've talked with multiple different people that have a high six-figure balance of cash and are "waiting" for the "right time" to invest. You may be thinking, "Wow, this is smart since the market is higher than it ever has been before." Here is the interesting thing about how long the people have been sitting in cash - one of them has been waiting for the right time since the 2008-2009 financial crisis. The other one - they've been sitting in cash since 1999!
For the person sitting in cash since 2009, the value of an 80% stock ($SPY) and 20% bond ($AGG) portfolio would've gone from $500,000 to $1.5 million. (Investing from Jan 1, 2009 - Oct 30, 2018)
For the person sitting in cash since 1999, the same portfolio would've gone from $500,000 to $1.35 million. (Investing from Jan 3, 2000 - Oct 30, 2018)
However, here are the times it becomes hard. Simply using 2000-2018, here are some of the balances of the account over that time frame (initial investment of $500,000):
March 10, 2003: $348,096
October 3, 2007: $642,532
March 6, 2009: $361,956
August 7, 2009: $498,000 (9 years and it's back to even - almost)
January 30, 2013: $755,095
February 2, 2015: $1,008,105
October 30th, 2018: $1,349,576
What a rough ride. Hindsight being 20/20, it's easy to look back and say that these investors are silly for sitting in cash. However, they can look back at the August 7th, 2009 balance and think they're the smartest ever - nine years with zero growth. Interesting to think about.
What does it all mean? Although cash can feel safe, strategies like dollar cost averaging allow people to invest it in a systematic way over time, using factors like time horizon and risk tolerance to help investors feel better about taking the leap into the market. People don't have to be perfect investors and make zero mistakes. The biggest investors in the world have made a lot of mistakes over time. The main key is to avoid big mistakes - especially with something like the stock market that neither you or I can control.
Going to Bonds
Over the last 30+ years people have thought of bonds as a safe haven since they've been in a bull market for that long. Interestingly, bonds get very little press coverage compared to stocks even though the bond market is bigger than the stock market. With interest rates slowly going up, bond prices are falling. October was a month of stocks *and* bonds going down, contrary to the thought I sometimes hear from people thinking that if stocks go down, bonds go up. That is not always the case. If people are going to re-allocate their portfolio, it's important to keep interest rates in mind and know that long-term bonds are more sensitive to interest rate increases than short-term bonds.
Timing the Market
Timing the market almost never works, especially on a consistent basis. It requires a lot of luck and also requires timing it correctly multiple times in a row. There are a lot of studies done that compare the difference in "investor" return vs. "investment" return. They show that timing the market actually leads to lower long-term return and provides no long-term benefit. Here is a link to a one-page PDF that outlines the last 20 years: American Funds - DALBAR study.
How Having a Plan Helps with Corrections
I constantly coach my clients on how to handle market corrections. Most (if not all) of them will experience multiple market corrections moving forward. I try to help them mentally separate their portfolios into segments - cash, bonds, stocks. It's also important to show them that holding 100% cash or 100% bonds would equate to about a 0% chance of success because we have to keep taxes and inflation in mind. I try to help people understand that their stock portfolio will experience the most volatility and it's simply a part of investing. It's also important to keep multiple years of income in a combination of cash and short term bonds, so that if (when) their stocks go down, they do not have to sell them at a loss. Luckily, technology helps run multiple scenarios so clients know how their plan is affected when losses happen and how to plan for them. However, technology still cannot help with the human feeling of potential investment losses. As an advisor, it's my duty to help and coach clients on their emotions, have difficult conversations, and care about their plan just as much as they do.
What I'm reading/listening to lately:
The Psychology of Sitting in Cash, Part Deux - Ben Carlson
Big Mistakes: The Best Investors and Their Worst Investments - Michael Batnick
The Truth About Money with Ric Edelman - Podcast