Have you ever been tempted to hold part of your long-term investment portfolio in cash so you can be ready to invest in stocks after a market drop? Or maybe you’ve thought about selling some of your stocks and keeping cash on the side to weather the storm. Sometimes referred to as a “dry powder” strategy, keeping cash on the side can give investors a greater sense of control. Recent economic uncertainty and market volatility precipitated by the coronavirus likely have more investors entertaining such strategies. Despite the current unique and challenging circumstances and the understandable desire to chart a safer path, Fisher Investments believes keeping cash on the side is likely not the answer. Rather than helping, holding cash may often cost you in terms of missed returns had you stayed fully invested and end up hurting your chances of achieving your long-term investing goals.
Fisher Investments believes long-term investors are better off not holding cash as part of their long-term strategies for several reasons. First, keeping cash on the side is a decision often driven by emotion, whether greed or fear. Second, at its core, it is a market timing strategy, that would have you moving in and out of the market or changing asset classes in the hopes of profiting from short-term market moves. Timing the market correctly is so difficult Fisher Investments doesn’t know anyone who can be successful enough over the long term to profit by it. Third, holding cash means you’re partially out of the market and you risk missing out on substantial market gains—a potentially steep opportunity cost.
This is not to say you shouldn’t have any cash on hand. While holding a portion of your investment portfolio in cash can open you up to risk, maintaining an emergency fund—3 to 12 months of highly liquid assets—is an excellent safeguard and a different thing altogether. Your emergency fund can help you meet unexpected expenses or deal with a loss of income without having to dip into retirement accounts and possibly pay steep penalties or sell investments at an inopportune time. Fisher Investments believes, however, that holding cash as part of your long-term investment strategy rarely pays off.
Keeping cash on the side can be an emotional decision
The decision to keep cash on the side is often driven by greed or fear and not by long-term financial goals. You may fear volatility or believe a market downturn is imminent and conclude that holding cash would enable you to invest at bargain prices when stocks are effectively on sale. Holding cash in your investment account may help you feel more in control, but it often results in poor timing decisions. If you wait until stocks are back up to buy, you’ll be buying back in at a high (expensive!). Or if you stay in cash waiting for an “all-clear” signal—which markets rarely provide—you may miss the market marching higher (and miss the gains you may need to achieve your long-term investing goals). In the long run, you may end up making important investing moves based on fleeting emotions rather than a disciplined and consistent, goal-driven strategy.
Keeping cash on the side can be a market timing strategy
Despite how cash on the side or “dry powder” strategies may be described by the financial media, they are essentially market timing strategies in which you are making buy and sell decisions based on your opinion of what the stock market will do in the short term. As Fisher Investments has often said, we don’t know any investor who is able to consistently time the market correctly.
To be a successful market timer, you need to be right twice: you need to correctly identify a high point at which to sell and a subsequent low point at which to buy back in. If you’re wrong at one or both of these junctures, your portfolio would likely have done better if you had remained fully invested.
It is very hard to succeed at timing the market because it is nearly impossible to predict what markets will do in the short term. While missed gains may be less noticeable than short-term losses, they can impact your ability to realize your long-term financial goals. If you partially miss out on a few strong recoveries, your average returns could be substantially lower relative to the overall market, and as this compounds over time, your final portfolio value could be much lower than expected. While keeping cash on the side can be an effective way to reduce short-term negative volatility, it frequently detracts from the long-term portfolio growth most investors need to meet their goals
Keeping cash on the side is time out of the market
It’s an oft-repeated nugget of investing wisdom that time in the market is what matters most when it comes to being successful and realizing your long-term goals. Keeping cash on the side means you’re partially out of the market. Given the uneven and unpredictable (in the short term) returns of the stock market, the portion of your portfolio that you hold in cash could miss out on big up days—crucial to capturing stocks’ superior long-term average returns. Missing out on just a few strong market days can have a big impact on your portfolio, your long-term returns and your ability to get where you want to go.
If you missed the 10 best trading days from January 1988 to March 2020 your annualized return would have dropped from 9.8% to 7.43%.[i] If 7.43% sounds perfectly acceptable, consider that a $500,000 initial investment over this period would have grown to $5,046,218 while at 9.8% the same initial investment would have grown to $10,290,805. As you can see in Exhibit 1, Fisher Investments demonstrates that having cash on the side when markets surge could have severe long-term consequences for your portfolio.
Cash might not be the best way to lessen short-term volatility according to Fisher Investments
Holding a portion of your portfolio in asset classes that tend to be less volatile than stocks, such as bonds, can help lessen short-term volatility while offering a better long-term return than cash. Bonds traditionally have offered relative short-term stability, which Fisher Investments recognizes can be an important consideration for investors who need regular income distributions from their portfolios.
Holding cash on the side might feel safe and give you a greater sense of control, but remember it also introduces new risks. Letting your investment decisions be influenced by emotion is risky, as is attempting to time the market. Over the long haul, Fisher Investments believes time in the market is a winning strategy while keeping cash on the side isn’t.
Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return. This article constitutes the general views of Fisher Investments and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.