By Andrew Bennison, M.B.A., J.D.
Placing one’s life savings in assets that may lose value can be fraught with emotions, high and low. When the market turns down and emotion sours, reminders like, “Valuations are more attractive than they have been,” or, “The only guarantee in investing is that cash loses value to inflation,” fall flat. They’re just too sterile for most of us.
Contextualizing works better. Permit me an example. Adele, Rod Stewart, and Rihanna all suffer from near paralyzing stage fright. My public speaking fears (and I suspect yours too) feel smaller when I picture any of the above getting sweaty palms and shortness of breath before going on stage. The professionals deal with same fears and self-doubts we do.
Investing can be similar. We create clean plans to stay invested and continue saving whether the market is up or down. Then the down comes. Financial media fuels our fears, keeping us glued to our screens. Neighbors quit bringing up their stocks at barbeques, leaving us to wonder whether they’re still up big or just playing it cool. Somehow, the plan’s salience fades like a distant memory.
What if I could show you that investors get paralyzing stage fright also? No, not through another survey. Those are famously error-prone and often bely actual behavior. The chart below shows how investors actually allocated cash in the last four drawdowns and the opportunity cost of their activity (i.e. foregone gains from being out of the market).
Over the last three short-term market bottoms (ex. 2022 since money market assets have continued to grow), investors continued increasing their cash positions for an average of 30 days after the market bottomed. The average opportunity cost of this mistiming was 17.5%. In 30 days! A money market fund yielding 5% would have returned ~0.4% over the same time.
Since October 2022 lows, investors have continued reallocating to the four largest money market funds despite the market being up 17.6% over the same period. Perhaps this reflects more attractive money market rates. Maybe it signals investors’ lack of trust in the rally. I suspect both are at play.
What I know to be true is this: on average, investors who tactically allocate to cash consistently undo the value of avoiding the downturn by missing the upturn. Timing the market is a fool’s errand and a costly one at that. After markets settle down, you’ll be thankful you stepped up to the stage despite that uncomfortable feeling in your gut. In the meantime, take solace that others feel the same.
*Money market assets adjusted for M2 money supply.
Sources: YCharts & FRED, Image by Wavebreak Media