Pulling out of stocks and bonds might feel safe amid volatile markets, but the decision still carries risks
For many safety-minded investors, the decision to flee the financial markets in favour of cash during times of turbulence is only natural. But consider some of today’s economic realities along with some nuances of financial planning, and the move turns out to be a lot less safe than it seems.
“When investors liquidate positions during market downturns, they end up with cash, but typically less than they could have had if they sold at a much later date – assuming markets, and the investments, recover and even rise,” noted Wall Street Journal writer Bailey McCann in a recent article.
Investors might think they can profit from tax-loss harvesting strategy by selling during a downturn, but they forget that it depends on the initial purchase price, as well as the manner in which they sold. If it turns out the initial price was still higher than the downturn price, they’ll end up having to pay taxes on the capital gains they realized by going into cash.
In the case of retirement accounts that require investors to take out a certain amount every year – RRIFs, in the case of Canadians – having too much invested in cash can be doubly devastating. “Even if you’re only spending a reasonable amount from those withdrawals, the cash is not working for you and you have to keep withdrawing and paying taxes on it each year,” said Richard Marston, a personal-finance author and finance professor at the University of Pennsylvania’s Wharton School.
With central banks’ policy rates hovering barely above zero per cent, cash certainly isn’t doing as much work as it used to. Some might think low levels of inflation will work in their favour, as less purchasing power is whittled away from every dollar they stash over time. But considering the fact that 1.8% currently qualifies a savings account as high interest, it’s clear there’s not much clearance for that strategy to fly.
And from a behavioural-investing standpoint, McCann noted that the longer an investor is in cash, the more likely they are to stay in cash. The knowledge that their wealth levels don’t fluctuate with the markets can make for a seductive form of comfort for investors who need their money to work for them.
As for those who don’t want to stay in cash forever, timing their re-entry into the markets is tough. “They think they’ll be able to get back in when the conditions are right, but the conditions are only right after they’ve missed the rally,” said Stuart Katz, CEO and chief investment officer of wealth-management firm Robertson Stephens.
