Is it smart to keep money invested in equities during market volatility?

Economic uncertainty, along with higher interest rates, is leading even experienced investors to take a second look at their investment portfolios. “People may have anxiety about their finances—both income and investments,” says Judith Ward, CFP^®, a thought leadership director with T. Rowe Price. “It can be hard to sit back and stay the course; there’s a real temptation to do something.”

An investor may feel compelled to reduce their equity investments in favor of something less volatile—in fact, some may have already moved assets out of stocks and into a money market investment or cash. There might be good reasons for changing an investment strategy, but acting on emotion or trying to anticipate the market’s direction can compromise a portfolio’s long-term return potential. In general, having an asset allocation aligned with the time horizon of an investor’s goals is the most prudent path.

Staying the course takes patience and discipline and can be especially difficult during times of uncertainty. Investors with a healthy dose of equities in their portfolio are likely to benefit from the long-term growth potential of stocks because, over time, the magnitude of market gains has been significantly greater than that of losses. (See “Look at the stock market through a 15-year lens.”) Of course, past performance cannot guarantee future results.

Another reason to stay invested is the difficulty of anticipating short-term market movements. “Very few of us can predict a decline coming,” says Roger Young, CFP^®, a thought leadership director with T. Rowe Price. “Similarly, it’s impossible to anticipate the timing of the rebounds that follow, even with a good understanding of economic indicators.”

The decision to reduce stock exposure—moving these assets into money market investments or cash—not only means anticipating when to exit the market, but also choosing when to reenter the market—thus requiring two acts of successful market timing. “Unfortunately, investors typically wait until the market drops to get out, then wait until the market shows improvement to get back in,” says Ward.

While it may be challenging to stick with a long-term strategy, doing so means an investor could be well positioned to reap potential gains as the market recovers. (See “The high cost of cashing out stocks.”)

To illustrate the benefit of maintaining equity exposure through all types of markets, let’s consider two hypothetical investors—the first adheres to a steady 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 kept their money and ongoing contributions invested, riding out the stock market’s ups and downs. The anxious investor moved their account balance and contributions to cash when stocks dropped 10% or more in a quarter and only jumped back into equities after a fourth consecutive quarter of positive returns. This behavior was repeated throughout several market cycles.

While both investors saw their portfolio balances decline during downturns, the steady investor took advantage of lower stock prices through ongoing contributions and was rewarded as the market recovered. Ultimately, the anxious investor’s account value was less than half of the steady investor’s account at the end of the period.

Motivation: Selling stocks to increase your cash reserve

For those nearing retirement or already retired, keeping a cash reserve that could cover one to two years’ worth of spending needs in retirement is a good rule of thumb. It is ideal to build up this reserve in the years leading up to retirement.

What an investor can do now:

An investor concerned about increasing cash on hand could direct any new contributions to a money market account rather than exchanging investments out of stocks all at once. This would allow the investor to revisit their allocation strategy once the market and their emotions are in a better position.

Motivation: Concern about losing money in the stock market and what may happen if market volatility continues

Suppose an investor's emotions got the best of them and they panicked and moved their equity investments to a money market investment. Perhaps it was unsettling to see an account balance slide, or they are remembering what happened to their investments during previous crises. Such an emotional response is understandable, but at some point, investors will need to get their strategies back on track. The people who were most impacted by the 2020 downturn were the investors who got out of stocks and didn’t get back in.

What an investor can do now:

“The best advice we can give is to not wait too long,” says Young. “There will be no all-clear signal to let investors know that markets have bottomed.” Consider investing a little at a time by gradually purchasing stocks. Investors don’t have to time it perfectly.

For those who have not made any adjustments to their investments but are still afraid of volatility, maintaining or modestly boosting an allocation to fixed income can help buffer against short-term declines. Even with bonds having a tough year in 2022, with current rates, they could still be an important part of your portfolio. The key is to look at their performance over longer time periods and not just one year.

If an investor feels their equity exposure is currently too high, they should avoid acting out of fear. Since an asset mix can be a moving target during periods of volatility, an investor could set a schedule to periodically reevaluate an asset allocation based on their time horizon and risk tolerance.