Why Going to Cash can Be Risky during Down Markets.
On the morning of February 24th, 2022, I woke up early to check the news on the CNBC App. A red highlighted banner flashed in front of me,“Dow Set to Open Down 800 points.” Not a good start to the day. I knew I better be ready for a long day. I knew the fear of losing money would be palpable in our client’s voices and despite my own anxiety and concern for retirees, I knew I needed to be a grounding source for our clients.
During the COVID-19 pandemic, the market corrected and there was plenty of fear amongst everyone. Fear mongering was palpable everyday when I stepped into my office. My manager at the time gave me a piece of advice, which I reminded myself on the morning of the 24th. His advice was simple. As a financial advisor, you have to remain calm and be empathetic. You can’t give in to the hysteria. People look to leaders during times like this. Be the leader they need and guide them through the rough seas of investing.
It was a great piece of advice and at the time changed my outlook on how I could be a better advisor. I realize now, his advice along with living through that particular market correction gave me confidence that I needed to truly help clients during times of down turns.
As expected, that Thursday was an incredibly busy day. I could sense everyone’s fear, frustration, and concern. I remember when one of my clients asked me if I thought we were going to war. This was prior to Russia invading Ukraine and I told him I didn’t know Through out the day I talked to many clients, some rational, some fearful, some in between. Regardless, I needed to make sure I kept myself calm and grounded.
The main questions I received that day revolved around the fear of the market slide… What should I do, should I go to cash? How can I run and hide from the market? How can I protect my money? I think I may put my money in a stable fund and just earn interest what do you think? What about Gold? These are all fair questions and questions advisors usually face when the market is in a down turn. In my own mind going to cash was also risky and probably not wise for the long term.
It is important to note that when the market is in a downturn, emotional factors such as fear, can cloud rational thinking and an individual can make an irrational decision that can negatively impact their financial portfolio. While going to cash may seem like a safe haven, going to cash actually carries risk called inflation risk or cash buying power risk.
Here’s an example. In June of 2022 inflation climbed to 9.1%. The highest it has been in 40 years. Now if you move your money to cash into a savings account, the average savings account pays, 0.08%. Your money may look good not going down, but it is losing money to inflation.
Here’s another example:
Let’s say you have invested $15,000. The market is correcting and you decide to sell at $10,000. You’ve just locked in a loss of $5,000. Now you don’t want lose more money so you go to cash and move the money into savings. The savings account is paying you 0.08%. That’s $8.00 on your money. If inflation stays at 5% over the next year, your $10,000 will be worth $9,523.81. You would have lost another 500.00 which is better than 5,000, but if you’re earning 0.08% per year for interest, it’s going to take you 900 YEARS to double your money to $20,000!
900 years is 9 lifetimes if you lived to 100. That’s a long, long time to make your money back, not to mention your money has already declined due to inflation at 5%. While going to cash may seem like a safe idea, as you can see, it still carries risk. So what do you do?
It’s important to note that everyone does not have the same financial situation or goals. You have to look at the individual and their financial needs and wants before suggesting anything. However, most people are encouraged to stay the course and keep a long term perspective when investing. When you do that, you’ll usually overcome the down turns in the market.
If you look at the history of the Dow Jones Industrial average, it is safe to say, that gains in the market are permanent, while declines are temporary.
Market corrections are never fun. Nobody wants to see their money decline, nobody. However, if you can stay rational and invest for the long term, even if you are retired, you can potentially find stocks that are being sold at a discount and as the market recovers you can take part in the gains. Sometimes, you just need to hold on. It’s also important to note that you can put some money to cash. It’s okay to have a balanced portfolio in which you do have money sitting on the sidelines. The extreme of selling everything and going to cash is where it can be detrimental to your financial portfolio. Finding balance is often a successful strategy.
Thanks for Reading!