The High Cost of Cashing OutMarch 11, 2020
- Cashing out of a declining market comes at a price.
- While you may avoid an immediate loss, you also potentially miss out on future gains.
- If you stay patient, and can absorb some volatility, the market's long-term trend can work in your favor.
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. Although past performance cannot guarantee future results, history shows that stock markets eventually recover. Investors who cash out not only could lock in investment losses, but could miss out on longer-term gains as the market recovers, hurting their chances of achieving long-term financial success.
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 all types of markets, let’s consider two hypothetical investors—the first sticks to his investment strategy despite market fluctuations, and the second becomes anxious during volatile markets and jumps in and out.
Both investors contributed $2,000 each quarter to their investment accounts. The steady investor (bright blue in the chart below) kept her money and ongoing contributions invested, riding out the stock market’s ups and downs. The anxious investor (dark blue) moved his account balance and contributions to cash when stocks dropped 10% or more in a quarter and only jumped back in to equities after a fourth consecutive quarter of positive returns. This behavior was repeated throughout several market cycles.
Stay invested in the market’s growth story
While both investors saw their portfolio balances decline during downturns, they continued to contribute to their accounts. The steady investor took advantage of lower stock prices through her ongoing contributions and was rewarded as the market recovered. Ultimately, the anxious investor’s account value ($180,602) was less than half of the steady long-term investor’s account ($472,955) at the end of the period.
Both began investing $2,000 each quarter beginning 2000 through 2019.
The “anxious” style of investor is assumed to be invested in 3-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 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.
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 typically have been followed by longer-term rallies.
Stay invested for market recoveries
The graph below 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 the two bear markets (defined as a decline of at least 20%), stocks were back to their prior levels within four to five years.
Trying to time the market can result in two types of losses. First, converting stocks to cash after they have lost value can lock in those losses. Second, you could miss out on gains when the market rallies if you wait too long to get back in.
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 absorbs short-term volatility can benefit over the long term.
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; S&P. See Additional Disclosures.
The “S&P 500 Index” is a product of S&P Dow Jones Indices LLC, a division of S&P Global, or its affiliates (“SPDJI”), and has been licensed for use by T. Rowe Price. Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services LLC, a division of S&P Global (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”). T. Rowe Price’s product is not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P or their respective affiliates, and none of such parties make any representation regarding the advisability of investing in such product nor do they have any liability for any errors, omissions, or interruptions of the “S&P 500 Index.”
This material has been prepared by T. Rowe Price for general and educational purposes only. This material does not provide fiduciary recommendations concerning investments, nor is it intended to serve as the primary basis for investment decision-making. T. Rowe Price, its affiliates, and its associates do not provide legal or tax advice. Any tax-related discussion contained in this material, including any attachments/links, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any tax penalties or (ii) promoting, marketing, or recommending to any other party any transaction or matter addressed herein. Please consult your independent legal counsel and/or professional tax advisor regarding any legal or tax issues raised in this material.
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