This topic is one the exercises the minds of financial advisers and investors on a regular basis and is certainly worth discussing at the moment, with volatility returning to markets. So it justifies a longish post and I am not restricting this to members, as everyone ought to appreciate these points.
Advisers don’t as a rule like clients to sell assets and hold cash because adviser fees are either a percentage of the assets they control, or based on trades. This is one reason why NotHarry thinks that the best advisers charge fixed fees: it takes away this inevitable bias against using cash as an asset class. Some wealth managers and platforms do charge percentage fees on cash holdings as well (which is a rip off, designed really to protect their earnings when clients have money out of the market).
A famous quote from the legendary Fidelity Special Situations fund manager of some years back is: ‘it is not timing the markets, but time in the markets’. What he was stressing was that trying to sell at the top and buy at the bottom (timing) is never really going to work and it is better to stay invested and be patient. It is pretty easy to prove that he is correct by trying to time markets yourself – trust me! There is other evidence, used in a slightly misleading way at times, showing that not being in a given market for just a few days would mean much reduced returns over time, as recoveries are often extremely rapid after dramatic sell offs and people miss the best ‘up’ days.
Why the latter observation is misleading is that it is based on the idea that someone is buying and selling tactically, so sells close to the top of the market (clever) but is not quick enough to buy back in at the bottom (psychology makes it hard for most people to buy a falling market). When the market suddenly turns after everyone has lost faith in it, and the cash gets put back in far too late, the timing advantage is lost. This is an entirely valid observation of reality, but it is misleading to use it as a generalisation, because there can be other good reasons for selling out and holding cash that are not driven by a motivation to be a tactical speculator.
Take another scenario. It is 1999 and you don’t believe in dotcom companies. You have made money on the general boom in Western market stocks (a ‘bull’market) but decide valuations are just mad so you sell out and go to cash. If you held your cash for 3 full years, you could buy a whole bunch of assets much cheaper in 2002. So this ‘intelligent’ timing worked well. It would have worked even better if some of your money was left in Asia Pacific markets that had bombed in 1996 (a currency crisis) and which did very well indeed as Western markets struggled. My advice at the time was exactly that.
So the issue is not so simple. How can you make decisions? There are some reliable rules or processes.
- The first is what is called valuation. There are a number of ways of deciding if stocks are expensive or not (in the Useful Links you can connect to Robert Schiller’s work if you really want to understand this subject). This varies across global markets, naturally. If stocks everywhere are expensive compared to the long term average, it might be sensible to sell.
- The second is time horizon. All major market corrections are part of a cycle and valuations of the market as a whole will recover. So if you are saving for a pension many years in the future you can pretty much ignore the cycle and let your fund managers take what advantage they can of it (at times when cycles turn, inflection points, good managers earn their fees, doing better than passive trackers). If you own just a few stocks of your own selection, you may need to reflect on what is changing and how to reposition – good luck, as I have never thought I was clever enough to do that. If you need your money soon, say to build a house, pay your pension income or similar, then the time horizon is very short and you need to take money off the table and have it available in cash, or you will maybe end up selling at exactly the wrong time.
- The third is diversity. You can in fact leave money in the markets (of various types) and also hold cash at all times. A “Boris” solution of having your cake and eating it. There is a cost to holding cash when markets go up – you miss out on the high returns. I consider that opportunity cost to be an insurance premium – the cash is there to spend when markets fall, so you don’t have to sell assets at the wrong price and can wait for the cycle to move on. The loss of upside return is the premium.
At the moment, on valuation grounds, most markets are expensive and some (bonds or fixed income stocks) very expensive. So if you have a need for cash and not much already on hand, selling some of your investments might be prudent. Bear in mid that you can often buy other assets that diversify stock market risk, but that is not at all easy at the moment. NotHarry knows of a few options and will write a members’ blog on the subject. I will also write longer piece on diversification in the near future!
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