Anytime the market turns south, a good number of investors feel safer by cashing out securities and salting away the money in cash or cash equivalents.
Many portfolios have a small percentage in cash. This serves as a buffer against volatility and allows investors to take advantage of buying opportunities.
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But in a market downturn, does it make sense to move a substantial portion of your retirement savings into cash to sidestep the risks of a volatile market? Here are some things to consider before going to cash:
— Holding too much cash is risky.
— Role of cash in a properly diversified portfolio.
— Navigating recessions with smart asset allocation.
— Rebalancing instead of cashing out.
— Asset allocation outperforms market timing.
— Risk of underperforming benchmarks.
Holding Too Much Cash Is Risky
Simply put, as inflation rises, investors lose purchasing power. Cash is guaranteed to lose value as long as any inflation exists.
According to a 2022 report from Vanguard, “How to Hedge Against Inflation in Your Portfolio,” holding too much cash increases investors’ risk of not meeting their financial goals.
“The only way to keep up with inflation is to hold your cash in investments that have the opportunity to go up more than inflation will,” Vanguard analysts wrote.
Role of Cash in a Properly Diversified Portfolio
Cash is a type of asset class, just like stocks, bonds or commodities. It helps diversify during bouts of volatility, says Robert Jeter, founder of Back Bay Financial Planning & Investments in Berlin, Maryland.
“At a minimum, it should offset some losses relative to the market,” Jeter says. “This has major behavioral benefits in looking at your portfolio compared to a benchmark.”
Cash can also turn a market downturn, which seems painful, into an opportunity. “Cash can be deployed at what is almost always more attractive asset valuations and prices. As markets decline, they tend to get less risky,” Jeter says, adding that from a statistical standpoint, the greater the loss, the higher the probability of more significant returns over the next 12 to 18 months.
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Navigating Recessions With Smart Asset Allocation
Tinkering with a portfolio, including impulsively selling investments in a downturn, can undermine its long-term intent.
“It is important to be appropriately positioned given your time horizon, liquidity needs and risk tolerance,” says Jamie Hobkirk, portfolio manager at Reynders, McVeigh Capital Management in Boston. She points out that various market sectors behave differently in a recession, with cyclical sectors typically pulling back more than the defensive parts of the market.
“As the business cycle transitions into recovery, stocks will start to rebound as economic growth picks back up,” Hobkirk says, adding that a portfolio that’s properly allocated for an investor’s goals can help avoid the need to sell stocks at inopportune times.
Rebalancing Instead of Cashing Out
Portfolio rebalancing means realigning asset allocations to maintain your target mix of stocks, bonds and cash over time.
For example, say your plan indicates that a portfolio of 60% stocks and 40% bonds is most suitable for you at this stage of life. If stocks rally and become 75% of your portfolio, while bonds are now just 25%, rebalancing means selling stocks and buying bonds to get the percentages back in line.
“Rebalancing is more than just switching to cash. It’s about adjusting your investments between things like bonds, U.S. equities and international stocks according to your long-term strategy,” says Prudence Zhu, founder and CEO at Enso Financial in Phoenix.
“Don’t just go to cash when the stock prices drop,” she adds. “You should regularly check your asset allocation and cash flow, not just panic and sell everything.”
She also cautions that retirement investors may not be well served by following in the footsteps of professional investors or institutions, who have different processes and objectives.
For example, she cites Berkshire Hathaway Inc. (ticker: BKR.A, BRK.B), which held a record $347.7 billion in cash and cash equivalents, representing about 27% of total assets, as of March 31. That was a significant boost from the $334.2 billion held in the fourth quarter.
Although Berkshire Hathaway does keep cash on hand to take advantage of opportunities, the company has a special situation in that much of its cash reserve is due to income from its insurance businesses.
Asset Allocation Outperforms Market Timing
Nervous investors will find plenty of encouragement to hide out in cash until some ill-defined moment when the market “returns to normal.”
However, volatility and downturns are normal parts of the market cycle. Investors who are waiting for calmer seas often have a difficult time knowing when to jump back in.
Even professional investors with an active management style consistently and reliably underperform indexes in aggregate and over time.
“There is a ton of data on professional investors and how they perform relative to passive benchmarks,” Jeter says. “The long-term track records are awful.” Trying to concoct an active strategy that outperforms the market over time is unlikely even among the most seasoned investors, he says.
“Retail investors have nowhere near the tools, and are even more likely to underperform,” Jeter adds. “A strategic asset allocation that is derived from their plan is the best course of action. That will change as the plan changes.”
Risk of Underperforming Benchmarks
While jumping in and out of cash may seem like a smart strategy in a recession or market correction, it increases the risk of selling low and buying back in too late.
“Staying the course over a longer term has tended to be the best course of action as assets tend to go up over time,” says Kevin Thompson, president and CEO of 9i Capital Group in Fort Worth, Texas. Trying to buy and sell at market highs and lows has lost investors money, Thompson says, because maintaining continuous market exposure from 2005 through 2024 resulted in a 10.4% return. On the flip side, he adds, citing data from J.P. Morgan, missing the best 10 days in the market reduced an investor’s return to 6.1%, and missing the best 20 days reduced it even further, to 3.5%.
“Market timing never works, because if it did, everyone would be rich,” Thompson says.
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Should You Go to Cash? Read This Before You Sell originally appeared on usnews.com
