Should you sell out of the market and go to cash when you’ve got a hunch markets are headed lower? Of course not. While moving to cash might feel good mentally and help you avoid short-term stock market volatility, it is unlikely to be a wise move over the long term.
Here’s why: When your money is in the stock market and the market is down, you may feel like you’ve lost money, but you really haven’t. At this point, it’s a hypothetical, or paper, loss. A turnaround in the market can put you right back to breakeven and maybe even put a profit in your pocket. If you sell your holdings and move to cash, you lock in your losses. They go from being paper losses to being real losses with no hope of recovery. And then you’re in the hole, forced to make up for your losses just to get back to square one. While paper losses don’t feel good, long-term investors accept that the stock market rises and falls. Maintaining your positions when the market is down is the only way that your portfolio will have a chance to benefit when the market rebounds. And remember, no market moves in the same direction forever.
When you sell your stocks and put your money in cash, odds are that you will eventually reinvest in the stock market. The problem inevitably arises, however, of trying to figure out when to jump back in. Trying to choose the right time to get in or out of the stock market is referred to as market timing. If you sold out of the market when stocks were tanking, that means you weren’t able to predict a peak. It’s highly unlikely that you’ll be any better at predicting a bottom and buying before things start moving up again. The lesson to learn here is that it is exceedingly hard to call both a top and bottom to a market cycle. The better approach is to ride out the ups and downs instead of dealing with the toll that inflation and opportunity cost can have on an all-cash portfolio.