Why It's Not Time to Panic

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By the time you read this, the incessant wrangling in Washington over the debt ceiling may finally be over -- although I wouldn't bet on it. Regardless, even though ditching your long-term investment strategy to flee to the sidelines might make you feel safer in the short run, it doesn't really make any sense -- and in the long run, you'll likely regret your decision.

Cash at any price
As you'd expect during a time of crisis, many particularly nervous investors have decided to sell stocks and other risky investments in favor of safe-haven assets. What's interesting, though, is the scope of the mass movements of capital recently. In particular, it's not just individual investors taking steps to protect themselves. Here are just a few happenings that TheWall Street Journal documented over the weekend:

  • Money market funds have used Bank of New York Mellon (NYS: BK) , JPMorgan Chase (NYS: JPM) , and other banks that they typically use as custodians for their assets to hold cash in FDIC-insured bank accounts.
  • Corning (NYS: GLW) reportedly moved $1 billion into FDIC bank accounts as well, turning away from short-term Treasuries and other government-backed debt.
  • On the other hand, the Treasury crisis has clearly spooked investors in mortgage real estate investment trusts. On Friday, Annaly Capital (NYS: NLY) , Chimera Investment (NYS: CIM) , and several other mortgage REITs fell sharply at the open because the rates on the repurchase agreements that these companies use for financing doubled overnight.

In addition, prices of gold hit another record. And oddly enough, longer-term Treasury bonds also saw buying interest, as the yield on the 10-year fell to its lowest level in nine months.

What's next?
Taking money off the table when times get tough usually feels like the right choice. But when you take a detour from your long-term strategy, it raises two questions: What are you buying instead, and when will you go back to your old investments?

With the first question, it's important to understand that holding cash is itself a "buying" decision. And in this case, it's not really clear exactly how safe cash is. If the Treasury defaults, you can expect confidence in the U.S. to plummet, and that could easily spill over to the foreign exchange markets. As a result, your "safe" dollar holdings could lose even more of their purchasing power -- even after a substantial move downward in recent months. In addition, although FDIC insurance is available on bank accounts, the FDIC is backed up by the federal government. If it defaults, why would your claims on the FDIC take precedence over all the other money the government owes?

The same concerns apply to long-term Treasuries. Although you can reasonably expect the crisis to resolve itself before a 10-year Treasury matures in 2021, a downgrade could cause interest rates to move higher -- thereby hurting the value of that bond.

The second question is even harder, because successfully timing the market is much more difficult than you'd think. With the stock market down sharply last week, it's already too late to get good value if you sell stocks now. Also, with precious metals investments like Central Fund of Canada (ASE: CEF) and iShares Silver Trust (NYS: SLV) already having clawed back much of the way toward their recent highs a few months ago, you'll pay a pretty penny to take advantage of their perceived safety.

Also, figuring out when to go back to your normal investing plan is tough. If you wait until the crisis ends to buy back in, then you virtually guarantee that you'll pay more than what you got when you sold them. Even worse, if you balk at buying right after everything's resolved in hopes that stocks will get cheaper, you could miss a huge rally -- just as investors on the sidelines did after 2009's market meltdown.

The better way
As hard as it is to see your stocks fall during a crisis, holding onto your normal investment mix often works best in the end, because you don't give yourself a difficult market timing decision to make. Even better, if you already have cash on the sidelines now, buying at the depths of the crisis can let you take advantage of temporary bargains and will often give you a gratifyingly quick profit once the crisis passes.

If you want some ideas for stocks you can buy for the long haul, take a quick look at this free special report with five stocks The Motley Fool has in its own portfolio. They have the staying power to last through tough times and help keep you from panicking.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter here.

At the time this article was published Fool contributorDan Caplinger  follows the rules of the Hitchhiker's Guide to the Galaxy to the letter. He owns shares of iShares Silver Trust and Chimera Investment. The Motley Fool owns shares of JPMorgan Chase, Chimera, and Annaly Capital. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool'sdisclosure policy, like Kevin Bacon in Animal House, urges everyone to remain calm.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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