Friday’s big 2.5% decline in the S&P 500 has left many investors nervous. After all, it wasn’t that long ago that the market sold off 10% to start 2016. And investors still remember late 2007 to early 2009 when stocks lost more than 50% of their value. In this week’s Weekly we discuss the merits of “moving to cash” in order to avoid the risk. We also review this week’s members-only new investment idea, a big dividend mortgage REIT that could actually benefit from more market turmoil.
Many investors feel the urge to “move to all cash” at the first hint of market turmoil (such as what just happened on Friday). And this urge is often fed by sensationalist news stories that suggest the sky is falling and everyone should take cover. At Blue Harbinger, our view is that it may be prudent to hold a significant amount of cash (note: when we say cash we mean in your brokerage account, bank account, money market instruments, short-term treasuries, etc., NOT actual cash), but you should NOT try to “time the market.”
What is the right amount of Cash?
Of course the answer to this question depends on your situation and risk tolerance. For example, it may make sense to keep some emergency cash on hand in case you have to pay unexpected bills, medical costs, or if you lose your job. Additionally, you’ll want to keep extra cash on hand if you have specific short-term goals like paying for a new house, a wedding, or a vacation. It makes sense to keep this cash on hand so you don’t run the risk of temporarily “losing it” due to market volatility.
However, beyond emergencies and short-term goals, the traditional wisdom is for investors to gradually reduce risk as they age by selling stocks and holding more bonds and/or cash. And considering our current low interest rate environment, combined with expected future interest rates hikes (remember bond prices fall as interest rates rise) it makes sense to hold more cash.
For some perspective on the right amount of cash, we can look to the most conservative retirement fund in Vanguard’s lineup, the Vanguard Target Retirement Income Fund (VTINX). This fund has only a 30% allocation to stocks, with the remaining 70% split between bonds and “cash.” Specifically, this fund has a roughly 20% allocation to short-term treasury securities (this is essentially a form of cash considering it’s backed by the full faith and credit of the US government and its yield is barely higher than 0%).
Don’t try to Time the Market!
At Blue Harbinger, we believe investors should set their long-term investment goals and then stick to them. For example, if you’ve determined that 20% cash (as in our example above) is the right amount for you, then you shouldn’t be raising or lowering that amount based on what happened to the market on Friday. In fact, trying to time the market is often the exact wrong thing to do. Moving in and out of cash on a short-term (or even daily) basis often result in expensive transaction costs, plus it can cause you to be sitting in cash when the market rallies, which means you miss out on big return opportunities. Too much cash can hurt you in the long run.
One of Warren Buffett’s famous quotes is “be fearful when others are greedy, and greedy when others are fearful.” In our view, this contrarian approach suggests that now is not the right time to be raising cash or moving into all cash. Instead, if you have a little extra cash on hand, now might be a better time to buy stocks (because they cost less now than they did before Friday’s tumble). But certainly don’t make any dramatic changes to your long-term investment strategy just because the market was down 2.5% on Friday.
This Week’s New Investment Idea:
Starwood Property Trust (STWD) is a big dividend (8.6%) mortgage REIT that could actually benefit from an uptick in market turmoil. Further, we believe Starwood inappropriately sold off on Friday (it was down more than 3%) because it was incorrectly lumped in with other big-dividend payers that sold off when the Fed suggested it may raise rates sooner than expected. You can read our full write-up on Starwood Property Trust here…