The Psychology of Sitting in Cash

A reader asks:

I took one piece of advice from a close friend that the market was too high and that I should go to cash and wait for a correction. I am still waiting. How do I proceed from the position I have of feet embedded in concrete?

Since I started this website, this is by far the most asked question I get from readers, which is unfortunate given the steady rise in the markets. This reader shared with me he’s been in cash for a number of years now and doesn’t know how to proceed.

The problem is not just sitting in cash per say. It’s really the mind-games that come about as a result of making a binary decision to go all-in or all-out. Tadas Viskanta from Abnormal Returns put it best when he once wrote:

Market timing is a gateway to cash addiction.

And that’s one of the biggest issues when you pull the trigger and go to all cash. It turns psychological warfare in your own head because there are always going to be good reasons to wait for a better buying opportunity. When stocks go up, you tell yourself you’ll wait for a correction and when stocks fall, you tell yourself you’ll wait for them to drop just a little further.

It’s easy to look back on it now and say how much of a lay-up it was to invest at the depths of the market crash in early 2009, but there weren’t too many people saying things were all clear at the time. Investors were scared and constantly waiting for the next shoe to drop. Ever since the recovery started people have been doubting it’s legitimacy. Pundits have been scaring people away with predictions of double dip recessions, hyperinflation and the collapse of the U.S. dollar.

Don’t let anyone tell you investing in this bull market has been easy. It hasn’t, but really, it never is.

When thinking about what those sitting on a pile of cash should do now, I could write about the length of the bull market in stocks or level of bond interest rates. But really this question has nothing to do with the financial markets and everything to do with human psychology.

I had another reader tell me he’s been in cash since 1999 — fifteen years of inaction. After seeing the aftermath of the tech bubble he couldn’t pull the trigger and get back into the market. Then the Great Recession shook his confidence in the markets even further. I asked this investor if he could explain to me why he thinks it was so hard to get back in. Here were his reasons:

1] fear
2] arrogance on my part thinking I can manage our funds as well as a RIA without incurring the costs,
3] and a loss of confidence in most all asset classes, most especially with our government’s meddling.

Both of these readers told me that they had rules in place based on technicals or moving averages that would give them a signal that would tell them when to get back into the market. But when those thresholds were hit, the fear of coming off the sidelines was too much to handle. Here’s what this same reader had to say about what he’s learned from sitting in cash for so long:

So I am living proof that the challenge in timing the market is being right both getting out and going back in… PLUS having the courage and confidence to take action.

When readers ask me what they should do when they’re in this position I can never fully answer their question because everyone’s situation and risk tolerance is different. My response is always that whatever you choose to do — dollar cost average over time, wait for a market correction, put it all back in at once, hire a professional — try to have a plan of attack that you can follow. It’s no good to create a plan that you have no chance of actually seeing through because you become paralyzed by fear or greed.

This dilemma has nothing to do with cash as an investment option. Or the current stock market valuations. Or the opportunities cash can bring about in a market crash or correction. Those things can be important to understand, but they don’t really matter if thinking about them causes you mental anguish and leaves your feet stuck in the concrete. It’s about having the ability to get over the fear of allowing market forces stop you from implementing an investment plan.

Cash is a bad habit most investors need to kick (Abnormal Returns)

Further Reading:
The Problem With Intuitive Investing



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What's been said:

Discussions found on the web
  1. innerscorecard commented on Mar 12

    I can’t imagine reading blogs like this and still being in cash for decades.

    • Ben commented on Mar 12

      There’s a ton of information and channels for advice out there. It’s very easy for people to take advice from what they think is a trusted source because they speak with a false sense of security. Unfortunately many people just get bad advice and then it’s even harder for them to trust people in the future.

      • Steve commented on Mar 13

        The friend who is a mechanic or doctor tells you to go to cash. So you comply? Hope you never need serious surgery

  2. John Richards commented on Mar 12

    I’m afraid of the market crashing as well, but I’m more afraid of missing out on market appreciation. Market behavior experts seem to think that’s unusual, so maybe that’s a lucky variation from the norm. I had a poor decision process but a good result when I started pulling out of stocks in late 2007. I limit myself to 10% adjustments monthly, most months I moved about 10% from equities to cash. I did get back in afterwards, at more like 5% a month, and I’ll admit it was hard to buy, but I was driven by the fear of missing the recovery. I guess I figure if the market stays down, everyone loses, and I’m fine from a relative standpoint. What chaps my hide is watching everyone else get rich when all I had to do was be invested! (This pertains to index fund investing in a 401k. Individuals equities are such a lottery that it feels entirely different.)

    • Ben commented on Mar 12

      Interesting. I like the strategy of limiting yourself to a certain % of your portfolio that you’ll move each month. Very good idea. It’s also nice that you understand which market move you will regret more. I like to ask people, “Would you rather miss out on the next 20% gain or 20% loss?” Figuring out your personal regrets is half the battle. Sounds like you have a good handle on things even if every buy or sell isn’t perfect.

      • John Richards commented on Mar 13

        Thanks, the 10% limit was an effort to stay grounded; 20 years of investing and I’m still a neophyte (a little knowledge is a dangerous thing). I’ve seen a lot of people crash and burn as they jump from one approach to another, hence the 10% rule. I started off clueless, learned the value of buy and hold, now mostly hold a conventional mix of assets and allocations; though I might overweight an asset class for a while. 2007/8 was an aberration for me – I was around 90% cash by the end of 2008, and then had to face the situation you noted in your blog of when to get back in.
        Recently I’ve become a bit obsessed with some of Meb Faber’s white papers / ivy portfolio w/r/t both timing and limiting investments to a few asset classes. It’s clearly not something to dive into until thinking through a lot of angles, testing with a small portfolio, and learning if I can stay on schedule….but it’s fun to think about, and if it gives you any thoughts that make you want to put pen to paper, that could only be a good thing… ;>)!

  3. PanamanianStrongman commented on Mar 12

    Great piece. Been there, done that. For me the evolution was to fix my equity allocation percentage (rebalancing annually), after which it became only a matter of which equities/funds to select, rather than how much to hold.

    • Ben commented on Mar 12

      Thanks. And good strategy. I find for most people the actual allocation matters much less than your ability to become comfortable with it.

      • Steve commented on Mar 13

        Asset allocation is the biggest determinant in meeting your goals. Being comfortable with a mix will not work if that mix won’t get you where you need to be. The objective is to reach your goal, so going to cash or having the wrong mix will not get you there

  4. melty commented on Mar 12

    Great blog post! The psychological wear and tear of making decisions to get in or out harms an investors confidence and leads to performance chasing or sitting on the sidelines. It is extremely stressful and damaging longer term.

    • Ben commented on Mar 13

      Thanks. Agreed. In the end most investors who try it only end up capitulating and making matters worse.

  5. Steve commented on Mar 13

    Never listen to friends. Never get out of the market if you need some growth. If you can’t handle volatility stay in cash. If you can afford it.

    • Ben commented on Mar 13

      Never take investing advice from your friends is a great rule of thumb. I like that one.

  6. Scott Boone commented on Mar 13

    Investors whom I worked with in my career always seemed surprised that, as professional asset managers, we couldn’t somehow anticipate in advance which way the market was going to move. After all, any fool (investors not included, of course) could see which way the market was going to move – after the fact! Early in my career, I struggled with a response to this sort of comment as our standard sales pitch seemed to imply that this was exactly what we could do for our clients. Of course, if it were this easy, we’d all be rich and be clients rather than advisors. Convincing clients to be and stay invested in good times and bad was one of the hardest tasks we faced. With every correction in the market, we could almost predict to the day who would call, pleading to go to all cash before they lost everything and who would then criticize us for not reinvesting when the market began to recover. As we often lamented, this would be a great business if it were not for all of these pesky clients!

    • Ben commented on Mar 13

      I get that question all the time too: Time to take money off the table? I guess learning how to anticipate those client reactions can be helpful to get ahead of things when you know they’re coming. Unfortunately, some people are beyond saving and will always over-react. Expectations up front and coaching/counselling along the way helps. But like you said, no easy answers.

  7. Mark Massey commented on Mar 13

    In March, 2009, there was virtually NO ONE saying that the market was at, or even near, a bottom. 90% were saying the S&P was going to sub 500…it was around 750 at the time. Hard to believe now but that was the consensus then from all the smart guys at GS and all the sell-side folks.
    I took $150K from my prime -1 (2.25%) rate HELOC and put it in about 7 or 8 equities (DOW, GPC and MAA that i can recall off top of my head) that had been beaten way down and had cut their dividends yet still yielding 6 to 7%. Invested it between mid March and late April of ’09. My after tax dividends more than paid my subsidized HELOC interest, and in 6 months or so, I was up 50%. In a year, I was up about 100%. Still own a couple of those positions today. Needless to say, way up in them.
    Paid back the $150K over the next couple of years and had more than that amount that was “house money” at that point. Was not fun on the way down, but I made it back quickly when it got to ridiculous valuations in early ’09. I recall that time well due to the unfortunate death (long battle with a sarcoma cancer) of my 66 yr old Mom on 4/10/09.

    • Ben commented on Mar 13

      Nice call. Many people don’t realize it, but 2008-09 was probably one of the 2 or 3 best buying oppprtunities ever. Sure, we’ll have bear markets and crashes in the future but that was something different than usual. That was the 2-3 time in 50 years type of event.

  8. Jason commented on Mar 14

    As soon as you start playing the timing game it just snowballs and becomes non-stop mental anguish, or at least a massive mental distractions from all the other things that matter so much more. That’s largely why I’ve committed to staying fully invested, as it removes all this doubt and second guessing, but of course I’d love to have a pile of cash waiting for the next market crash!!

    • Ben commented on Mar 15

      Yup and there’s the temptation that so many investors have. The problem is that it always seems so easy in hindsight but never in real time, so investors that have no business trying to make a binary call will continue to do so.

  9. Jim Clark commented on Mar 19

    One thing that I have found in 30 years of investing is every month write down what my investments are worth and keep the sheet for future reference. That way I can look back and see that I survived bear markets and because of monthly contributions, I eventually ended up richer than before.
    As you pointed out in the “world’s worst market timer” blog last year, the last half century has shown if you stay invested, you will get rewarded

    • Ben commented on Mar 19

      Sounds like a good system to me. I could almost write the opposite side of this story and call it the Psychology of Sitting in the Market. Neither of the two choices are easy but only one has been shown to build wealth over time.

  10. Joe Walker commented on Mar 25

    This is really dumb advice, if Ray Dalio is right and the end of the debt super cycle is coming to an end, ( it has been going on longer than you have been alive-33 years) it really won’t matter what your stock PE’s are at.

  11. Matthew Heaney commented on Apr 05

    I don’t understand why people make investing so complicated. Just buy a total market index fund and be done with it. If valuations are high (as they are now), then save more, or plan on working longer.

    • Ben commented on Apr 05

      I’ve discovered that there’s no easy position to be in. Most people want things to work out perfectly and have a hard time planning for contingencies. My thoughts are every strategy is terrible except the one that works for you personally and allows you to minimize your regrets the most. People just have a hard time excepting trade-offs when trying to minimize those regrets.

      • Matthew Heaney commented on Apr 05

        Except that the best strategy for most retail investors is to simply buy an index fund. Just capture the market return.