No doubt about it. Equities have had a really bad start in 2016, as in historically bad. So I’m not surprised that several of my clients are asking about “going to cash.” Currently, cash is paying close to zero, but at least it is not negative, so why not cash out entirely? For several reasons, I say:
We are in this for the long term. We are “portfolio investors,” as opposed to stock pickers and market timers, and we are constantly looking for good selling and buying opportunities. Over and over. For the long-term portfolio balance to work, we need the benefit of well-placed trades to add to total return, and we need to allow asset classes enough time to provide us with buying opportunities in choppy markets. Stocks and bonds, international and domestic, managed futures and hedge funds are all placed in your portfolio so they can play off of each other in various types of market environments.
Here’s how it works: we buy a selection of asset classes, and we choose the managers we think are best-positioned to take advantage of opportunities in each class. Not individual stocks. Not specific sectors. We aren’t looking for the underappreciated gem or the quick-hit small caps. We buy into big broad slices of U.S. large and small caps, emerging and developed markets, natural resources, real estate, and managed futures and hedges in the form of index-style and actively managed mutual funds, a few master limited partnerships, and various exchange-traded funds (ETFs). The theory is that ongoing exposure to these asset classes reduces volatility and maximizes long-term returns since each segment tends to react differently to the same market event.
Yes, markets are reacting to China right now. But we are seeking to take advantage of these swings. Our goal is to take gains and minimize losses, and then redistribute to other parts of the portfolio that benefit us. The portfolio effect has proven to yield a better total return over the long term than attempts to time the market by moving into cash or individual stocks. Although diversification does not guarantee against loss, diversification is the most important tool when it comes to managing risk, allowing you to remain invested long enough to attain your long-range financial goals.
All along the way, risks are limited in two important ways. One, we stay in the market. Markets moves can happen quickly in either direction, and the danger of getting whipsawed is great. When markets are down, portfolio rebalancing forces us to do some opportunistic buying (and selling), so we’re positioned to benefit from the relatively few (and hard to predict) days when stocks really put on gains.
Secondly, as long-term portfolio investors, we get dividend payments all along the way. If we sell all of your equities and go to cash, you end up losing the extra bump up from stock dividends. Rebalancing by buying low with those dividends is the icing on the cake. By staying invested, we get appreciation, investable income from dividends, a chance to realize gains programmatically and to reinvest those gains in a timely fashion. Dividends, if steadily reinvested, and can really amp up your performance over time.
We also help your overall tax situation by tax-loss harvesting, a fancy way of saying we look for opportunities to sell some securities at a loss in order to offset capital gains taxes. These advantages are eliminated when the entire portfolio is terminated and everything goes to cash. Then, losses are truly locked in.
Mostly, though, the portfolio investor approach should end a client’s concern about selling and going to cash. If your portfolio is customized to your finances and risk tolerance – something we make sure of here at LNWM – it is then appropriately balancing stocks to bonds, international to domestic, as well as some alternatives to ramp up diversification and soften downturns. You do not need to panic during times of heightened market volatility and falling prices. Why? Because your portfolio is designed to take advantage of such swings.