The Psychology of Sitting in Cash, Part Deux

In early-2015 I wrote a piece called The Psychology of Sitting in Cash where I tried to answer the following reader question:

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?

I never did hear back from this reader to see how they handled this situation.

There have been opportunities to put money to work at lower levels in this time. In the summer of 2015, the S&P fell more than 12%. Then in early-2016, it fell more than 13%. Earlier this year stocks were down over 10%. In each of these cases, foreign stocks dropped even more.

But if they didn’t take advantage of those corrections and are still sitting in cash, things have gotten even more painful. Even after the latest bout of selling, the S&P 500 is still up a little more than 40% in total or just shy of 10% annually since I wrote that piece.

Professional investors like to talk about how holding cash gives them optionality and the ability to swing at a fat pitch. That may be the case, but when you consistently hold a large majority of your entire portfolio in cash all it does is add pressure to the timing of your buy and sell decisions.

I’ve heard from countless people over the past 6 or 7 years who were scarred by their experience in stocks during the financial crisis who have thus sat out all or the majority of the bull market.

Here are some considerations for those who are sitting on a big pile of cash or are thinking about raising cash now that we’re in the midst of another correction:

Corrections & bear markets don’t make it any easier to pull the trigger. You would assume it becomes easier to buy stocks when they’re falling but cash is a comfortable place to be during a correction. It’s like you’re tucked in under your warm comforter on a freezing Saturday morning in the winter and you never want to get out of bed.

When stocks begin to fall that comfort can lead to a cash addiction where you keep telling yourself you’ll buy when stocks fall a little further or the dust settles. And each time they fall you move that hurdle to buy just a little higher until you’re never able to pull the trigger.

Waiting is the hardest part. Let’s say you sold out of your stocks after the lights out year in 2013 that saw the S&P 500 rise more than 30%. “Too far, too fast,” you may have thought to yourself. Since 2014 the S&P is up around 60% or so. Just to get back to those levels where you got out, stocks would have to drop 35%. Waiting for this type of pullback can wreak havoc on your psyche when it doesn’t come right away.

Drop the anchor. Continuing with this same example, let’s say you did sell out and plan to wait so you can break even on this timing trade. Making your buy decision strictly based on when you sold will likely only compound the issue. Make your investment decisions based on the present, and more importantly the future, not the past. Anchoring to previous market levels is a good way to compound previous mistakes.

Timing the market requires being right twice. It’s hard enough to nail one correct call about the markets in terms of magnitude and direction. A handful of people seemingly nailed the call to sell risk assets leading up to the financial crisis. You could probably count the people on one hand who correctly made that sell call who also made a buy call on the other side.

Most simply clung to their bunker mentality and couldn’t bring themselves to see a light at the end of the tunnel. The worst part about going all-in or all-out is you have to get both of those decisions right to succeed. This is not easy to say the least.

Extreme positions in the markets can be addicting. There’s nothing in the investor’s handbook that says you need to be all-in or all-out to succeed. Investing is a game which is won by those who think using probabilities, not certainty. No one is smart enough do the red light/green light thing where you’re consistently trying to figure out when to go all-in and when to fold. Markets are rarely black or white and the ability to stay in the game often requires a delicate balance between many competing forces.

If you’re not a world-class hedge fund manager, this game probably isn’t for you. The greatest investors in the world have a difficult time predicting the direction of the markets and the timing of those moves. The fact that so many professional investors are wrong on a consistent basis should be a clear signal that humility should be your default position when thinking about trying to outsmart the markets.

However your portfolio is positioned at the moment between the spectrum of fully invested in stocks to completely out of the market and sitting in cash, the longer you wait to construct a plan the harder it is to take action when need be.

There are no perfect allocations or times to invest in risk assets. These things will only be known with the benefit of hindsight.

Figure out an allocation that works for you and avoid guessing what will happen based on your feelings.

Further Reading:
Avoiding the Extremes


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