Taking a Cash Position May Be Riskier Than You Think

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cash in shoe boxWith the U.S. equity market pulling back more than 10% this month, many investors may be looking to get out of stocks and go to cash because they fear a repeat of 2008's market meltdown. While exiting the market may take your fears away, it could also remove something else -- your ability to grow your portfolio large enough to reach your goals.

"For folks who say they want to avoid another 2008, what they have to remember is if they take a step to do that, they also avoid a 2009," says T. Rowe Price certified financial planner Stuart Ritter. "Because you don't know what the market is going to do, by avoiding any future losses, you also avoid all future gains."

Appreciating the Long-Term View

Ritter says if you exited the market at its bottom, in March of 2009, your portfolio would not have enjoyed any growth from the recovery rally that added 26.6% to the S&P 500 ($INX) last year. He points out that no one can predict when we'll experience another big rally, so by leaving the market, you may actually be leaving money behind as well. That 26% growth from 2009 would go a long way toward funding retirement income, mortgage payments, college tuition and other luxury items that will certainly cost more 10 or 20 years into the future.

Even with the volatility we've seen in equities, including market crashes in 2001 and 2008, Ritter emphasizes that if you'd stayed invested in the S&P 500 over the last 15 years, your portfolio would have enjoyed an average annual return of 7% per year. That adds up to a 170% increase on a compounded basis. Over time, the markets always look better than they appear when you follow the news of what's happening day to day.

For many, deciding whether to go to cash often becomes a battle of fear vs. risk. You might eliminate your fears, but "you run the very high risk of not having enough money to buy whatever it is you want to buy because the price has gone up so much and you haven't gotten any growth," says Ritter.

The Trouble With Timing the Market

Going to cash also means you believe you have a knack for timing the market, which most experts say is nearly impossible to do. Not only do you have to be right about when to leave the market, you also have to pick a good time to get back in. Some active money managers do well at adjusting the level of equities in their portfolios month to month, but can most individuals match the performance of professionals who track the markets closely?

"What you don't want to happen is to have an event like 2008, and at the bottom, you can't take it anymore and have to sell," says Maury Fertig, chief investment officer of Relative Value Partners. Those investors who bailed out of the market in March, 2009, had the worst timing of all because they held on through all the losses, then missed out on all the recovery, too. "In that scenario, if you went to all cash, it was very costly."

Recent research from Fidelity Investments shows how exiting the market during the market crash hurt some 401(k) investors. The small percentage of Fidelity 401(k) participants who dropped their equity allocation to zero between the fourth quarter of 2008 and the end of the first quarter of 2010 experienced an average loss of 6.8% vs. a 55% gain for the majority of Fidelity 401(k) account holders who stayed the course.

Stick to Your Plan

Ritter suggests that before going to cash, investors should ask themselves, "Is this in the best interest of achieving their goals or just a reaction to what they read that the market did yesterday?"

Investors can also avoid the decision by using target-date and life-cycle funds that are designed to automatically rebalance and adjust based on investors' goals. Sticking with an investment plan that will get them closer to their chosen goals is the only way for investors to cash in.
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