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The High Cost of Cashing Out
Help your clients understand the benefits of staying invested when the market takes a dip—and how cashing out can result in unnecessary losses.
When the stock market takes a dip, moving to cash can be a tempting option for investors seeking a respite from volatility.
However, cashing out of a declining market could come at a cost. For investors who choose to cash out during a market downturn, this can create several issues.
First, those who exit before the market corrects essentially lock in their investment losses. Doing so eliminates the opportunity to benefit from recovered returns.
In addition, a premature market exit can hurt an investor's chance of achieving long-term financial success. Even as the market experiences short-term fluctuations, history indicates that the stock market follows a general upward trajectory.
Short-term pain, long-term gain
Remember, long-term investment goals require a long-term perspective, particularly during periods of heightened market volatility. While it’s hard to watch your portfolio fluctuate with the ups and downs of the market, sticking with your long-term strategy can pay off over time.
A tale of two investors
To see the benefit of staying invested through varying market conditions, let’s consider two hypothetical investors.
Investor 1 sticks to their investment strategy—despite market fluctuations, they choose to remain invested.
Investor 2 becomes anxious during volatile market conditions, causing them to periodically exit and reenter based on short-term performance.
Both investors contributed $2,000 each quarter to their investment accounts. Investor 1 (blue in the chart) kept their money and ongoing contributions invested, riding out the stock market’s ups and downs. Investor 2 (orange in the chart) moved their account balance and contributions to cash when stocks dropped 10% or more in a quarter. They only felt comfortable putting money back into equities after a fourth consecutive quarter of positive returns. This behavior was repeated throughout several market cycles.
THE 20-YEAR MARKET PERFORMANCE OF INVESTOR 1 AND INVESTOR 2 FROM 2002 TO 2022
Both began investing $2,000 each quarter beginning in 1990 through the fourth quarter of 2022
Investor 2, the anxious style of investor, is assumed to be invested in three-month Treasury bills as a cash equivalent. The $2,000 contributed each quarter in this example assumes minimal interest earned. The anxious style of investor also assumes that cash is invested in Treasury bills during those periods when it is not invested in the stock market. The performance of stocks shown is that of the S&P 500 Stock Index, which measures the performance of large-capitalization companies that represent a broad spectrum of the U.S. economy. Charts are for illustrative purposes only. Investors cannot invest directly in an index. Past performance cannot guarantee future results.
Sources: T. Rowe Price and S&P. See Additional Disclosures.
How investor behavior impacts long-term returns
While both investors saw their portfolio balances decline during downturns, they continued to contribute to their accounts. Investor 1 took advantage of lower stock prices through their ongoing contributions and was rewarded as the market recovered. Investor 2 earned less than a quarter of what the steady, long-term investor earned at the end of the period. Investor 2 exited before the market had the opportunity to correct, essentially locking in their investment losses. Doing so eliminated the opportunity for them to benefit from a recovery.
In times of stress, we feel the need to do something—even when the best course of action may be to stick with the plan we already have.
It's possible to profit from patience
It’s nearly impossible to time the market and identify its peaks and troughs. If history is any guide, short-term drops in the stock market are typically followed by longer-term rallies.
RECENT BEAR MARKETS AND CORRECTIONS
Occurring between January 2000 and December 2022
QE = quantitative easing.
Reflects an investment of $1,000 on December 31, 1991. There were no corrections or bear markets between 1991 and 1999. Drop is based on the percentage drop from the highest market index value just prior to the correction to the lowest market index value. Recovery is defined as the length of time for the market to return to the previous highest market index value, rounded to the nearest number of months.
Sources: T. Rowe Price and S&P. See Additional Disclosures.
Drop is based on the percentage drop from the highest market index value just prior to the correction to the lowest market index value. Recovery is defined as the length of time for the market to return to the previous highest market index value, rounded to the nearest number of months.
Sources: T. Rowe Price and S&P. See Additional Disclosures.
Stay invested for market recoveries
The graph above shows that after market corrections (defined as a drop of at least 10%), the stock market typically recovered lost ground after three to six months. For two of the four bear markets (defined as a drop of at least 20%), stocks were back to their prior levels within four to five years. In 2020, the coronavirus shock lasted even shorter than other bear markets, and stocks returned to prior levels within five months.
Don’t let volatility change your plan
Market volatility is a given. Short-term downturns can be disconcerting, and they may heighten anxiety among some investors. If the stock market’s historical trends hold true, a patient investor who outlasts short-term volatility can benefit over the long term.
For additional resources, such as how to help your clients understand the role of fixed income, keep a long-term perspective, and chart a steady course, visit Speaking of Markets.
Additional Disclosures
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Important Information
This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action. This information is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types; advice of any kind; or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision.
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