Investment Corner: Holding Cash on the Sidelines
The phrase “buy low, sell high” sounds like the perfect investing formula. I’d say pretty much any investor would sign up for being able to repeat that outcome over and over.
In order to achieve the “buy low, sell high” outcome, there are two possible strategies. In the first one, you keep some cash free and then wait for the market to drop, or for the stock you want to drop. Once it does drop, you buy at the lower price and then hold on and wait for it to recover. At some point, when the stock has gone up enough to meet your goal, you sell it and bank your profit. Then, you sit out of the market with your cash on the sidelines and attempt to repeat it.
While this strategy sounds fairly simple, there are some problems with it. It is essentially the same as timing the market, and as I’ve explained previously, there is strong evidence showing that timing the market most tends to reduce the average return for an investor. You would need to correctly guess when the market is near its low, and again when it’s time to sell—a very hard combination to successfully achieve.
Another reason that the strategy doesn’t work is because it keeps capital on the sidelines instead of in the market. It can take months or years for a stock to drop to what you might view as a good price, and your dollars sit on the sidelines in the meantime. That money is most likely in a cash equivalent where average earnings are well below the average gains of the market. Even worse, what if the price of the stock or fund that you are tracking never does go down? You could be missing huge gains in the market!
Generally speaking, it can be smart to keep investable assets out of the market if you don’t want those assets exposed to market risk. It is not a good idea, in general, to hold money out of the market that you intend to invest in stocks. On average, time that your money is out of the market and sitting in cash is time that you’ve lost out on possible growth in the market.
The second strategy for achieving the “buy low, sell high” outcome is simpler: buy a diversified group of stocks (via mutual funds or ETFs) and hold on to them for the long run. There are no guarantees in investing, but over the past 100 years the S&P 500 Index has an average gain of about 10% per year. If you owned all 500 of the companies in that index, you would no doubt have some winners and some losers among them. But overall, you would be buying your portfolio low and selling it high, which is exactly our goal. Taking it a step further, more diversification using smaller companies and international stocks can help reduce dependence on any one part of the market.
More than one hundred years of evidence shows us that keeping cash on the sideline is not a reliable way to increase your investment returns. If you have cash that you want invested in the market, do it. If you want to hold onto some cash, that’s fine, but I don’t recommend doing that with monies that you intend to invest in the market. Try not to get caught up in timing things, where you can end up missing out on periods of strong gains in the market.
How ever you choose to handle your cash, invest smartly and invest well!
Larry Sidney is a Zephyr Cove-based Investment Advisor Representative. Information is found at https://palisadeinvestments.com/ or by calling 775-299-4600 x702. This is not a solicitation to buy or sell securities. Clients may hold positions mentioned in this article. Past Performance does not guarantee future results. Consult your financial advisor before purchasing any security.
