Got Extra Cash? Should You Put It To Work In This Market Environment?
Some investors with a stash of extra cash may be thinking about how and when to enter the stock market during this volatile market environment. Perhaps some sold just prior to the market downturn or others may be holding on (for years?) waiting for an opportune time to invest. Since the stock market has the unique ability to make nearly everyone feel terrible pretty much all the time, the decision when and how to reengage the market can be a nerve-racking experience.
Cash Can Be King…
Assembling a cash pile that can take care of day-to-day expenses for at least 3 to 6 months should be a goal for all investors. Also, if the extra cash is needed for upcoming expenses (car, house, tuition etc.) in the next five years or so, then not investing in the market is likely the more prudent decision.
A standstill approach with extra cash is popular these days and understandable given that fears are amplified due to the global pandemic and deep recession. Therefore, re-engaging the stock market is particularly scary to many since personal safety and financial security are threatened. In fact, cash hoards are at extreme highs for many investors. In the chart below, cash hoarding levels for 1.8 million Merrill Lynch clients are at highs not seen for years given heightened pandemic fears.
…But Extra Cash Can Be Trash
A higher than necessary cash hoard can feel like a warm comforter on a cold and dreary (bear market) night. However, staying under the cash covers can be costly over time especially now that the Federal Reserve Bank has chopped short-term interest rates to essentially zero. However, staying under the cash comforter for too long with too much cash can be costly, like some experienced post the 2009 stock market recovery.
With the bond market signaling meager inflation over the next ten years, cash holders may likely continue to lose money after inflation and taxes take their cut. As the chart below shows, owning 10-year U.S. Treasury bonds also appears to have challenges from a money-making standpoint. After inflation is accounted for, a 10-year bond will return a negative 1.25%. Yes, it’s a money losing approach but at least one is losing money safely with U.S. government bonds.
The stock market is never obvious. It is designed to fool most of the people, most of the time – Jesse Livermore
If you’re an investor who is lucky enough to have extra cash to invest during these volatile markets, what approach should one take that can payoff down the longer-term road? Knowing the best time to invest is never obvious however there are two main approaches to re-enter the market.
Option 1 - Jumping In. This approach is the hardest emotionally given scary headlines, volatility and the biggest chance for regret. However, for longer-term investors with a higher risk tolerance, there’s usually no better option than this Band-Aid rip-off approach based on past market performance.
Looking at long-term market returns, investing a lump sum for the longer-term can yield attractive returns. In fact, as the chart below shows, investing all-in up front, versus waiting many months or years, greatly increases the odds of generating positive returns over time.
What about investing all at once during volatile, bear markets? This past April was one of the best months ever for the S&P 500 index with a 12.9% gain for the month. The table below shows that since 1929, even after massive rallies in a month like April, the market continued to post attractive returns one, three and five years later. The market was positive about 60% of the time one year out, 75% of the time three years later and nearly 90% of the time five years later after huge up months like April.
Option 2 - Wading In. The average length of a bear market is 10 months, much shorter than the average length of a bull market of 2.75 years1. However, automating the investment of cash through a volatile bear market can still provide a sufficient timeframe to execute.
The key with this lower and slower approach is to automate the investment into the market as much as possible. This can minimize the emotional second guessing and regret versus a single, all-in approach. By choosing a timeframe, for example every two weeks or month over a certain period of time, an investor can fully enter the market as bear market conditions play out. Keep in mind that this approach can still involve regret if the market recovers much quicker with greater upside than expected. It’s important to remember that this dollar cost averaging approach is already a widely practiced strategy by many with regularly scheduled 401k plan equity contributions.
Just Say No To Nothing
Another option is following an investment plan that combines the two approaches. Jumping in and then wading in would present the opportunity to be a little right and a bit wrong which can lower angst and regret. Most important is to not hunker down under the cash comforter with too much extra cash for too long. Cash can be very comforting during a volatile bear market and help one sleep better at night. Over time, however, staying glued to the high cash stash can be an expensive and regretful decision as inflation’s purchase power erosion takes hold over time.