Cash is Risky

When considering what to do with the growth-oriented part of your portfolio, have you considered how dangerous it might be to hold cash? Before we get into the nuts and bolts of the problem with cash, let’s review how difficult it is to tactically manage around corrections and bear markets. Having discipline and a well thought-out strategy certainly helps. But trying to time around events like yesterday’s +10% move is impossible.

We’ve recommended larger-than-normal cash balances this year, and have discussed being exposed to traditionally defensive sectors such as healthcare and consumer staples. However, being all-in or all-out has repercussions, and probably negative ones. How can anyone manage in an environment where the market can move five percent one way or the other in a single day?

What about today’s sudden DOW plunge of -270 points (from high to close) in the last ten minutes of trade, on the mere mention that General Electric’s CEO, speaking at a dinner reception in Europe, lowered their 2009 forecast?! There wasn’t even a press release from the company, just rumor and innuendo, moving the market in seconds.  This sort of volatility is more common than you may think.

Cash is Risky

One key component of managing risk, however, is to not move too far away from the benchmark, as you can increase the risk that the benchmark moves one way and you move in the exact opposite direction. Therefore, most growth oriented investors forget how risky it is to be completely out of the market! Many investors think of risk in terms of loss. However, risk can also be defined as missing an opportunity. At the end of bear markets, those sitting entirely in cash significantly under-perform a market that shoots higher. It is a careful process in times like these to manage both sides of the equation.

Market Whipsaw

The headlines today suggest the economy is a mess. Wouldn’t investors be better off completely out of the market? If you sell everything now, you raise the specter of a whipsaw. Getting whipsawed increases the likelihood of losing out to the benchmark as you lose the resulting gain of the next move up. The whipsaw takes place when you have maintained some long equity positions despite the decline, and you throw in the towel close to the bottom. Days or weeks later, the market moves appreciably higher. Now that you sold the positions you’ve doubled your pain as you are no longer well positioned to benefit from a bounce or a new bull market. This is not prudent money management.

Maintaining a long-term discipline is critical during periods like the one we are in. Reacting to the news of the day won’t fulfill your long-term financial objectives. Maintain your allocation and to stick with your strategies.

History as a Guide

History has shown that recessions, corrections, and bear markets occur regularly. Although they are painful, the stock market has shown the ability to recover. We also know that the stock market typically leads the economy by six to nine months, so drastically altering your investment game plan in the middle of the game could be a dreadful mistake. With change comes opportunity, and we at IWAE will seek to adroitly manage through this period and position ourselves with proper care, always mindful of the risks associated with each asset class.

Good Luck