Going to Cash Can Be as Costly as A Market Crash
The comments below are an edited and abridged synopsis of an article by Lance Roberts
Going to all cash in your portfolio to avoid a crash can be just as costly as the crash itself. Yet a recent CNBC article quoted a $200-billion money manager suggesting “every stock market investor should be ready to go to cash.”
There is an essential distinction between going to all cash and raising cash to manage risk.
When going completely to cash in portfolios, it triggers emotional behaviours that negatively affect portfolio outcomes.
Over the past decade, Roberts has met with many individuals who went to cash in 2008 before the crash. They felt confident in their actions at the time. However, that confidence gave way to confirmation bias after the market bottomed in 2009. Nevertheless, they remained convinced the bear market was not over and continued to seek confirming information. As a consequence, they remained in cash.
Up for discussion: The fear of being wrong; the cost of waiting; never go 100% into cash; and it’s never easy.
The problem with going to all cash in a portfolio is that it becomes psychologically challenging to redeploy that cash in the future. To better navigate markets over time, choose a base level of exposure that you will never go below no matter how bad it gets in the market.
The benefit of having a base level of exposure is that as the market begins to recover, it becomes psychologically easier to buy into an existing allocation that is beginning to recover. However, since invested capital was protected from the decline, that capital gets quickly reallocated to equity risk at depressed levels.
While it may seem logical to go to cash to avoid crashes, the risk of mistiming the event can have the same negative effect on financial goals as the crash itself. Notably, managing risk is not the same as avoiding risk.
We can’t invest capital without the acceptance of risk. However, we can take actions to minimize the impact of risk when things don’t work out as anticipated.