Should you cash out of stock funds in your retirement savings accounts now that you’ve regained some losses? After all, even if the coronavirus stock market correction is easing and IRA and 401(k) balances are rebounding, a recession has begun.
This recession could be the worst since World War II, Bank of America Global Research predicts. And once government stimulus ends, 401(k)s and IRAs could stagnate or worse. Today reminds many savers of how their retirement savings got clobbered by the 2008-09 financial crisis — and stayed clobbered for a long time.
So how about it? Is the smart move to go to cash? Or at least to go to a lot of bonds?
Not according to history. Take the 2008-09 financial crisis. The stock market lost half its value in that span. From its peak in 2007 through its 2009 trough, the market plunged 57%. It looked like the perfect time to go to cash, to get out of stock funds.
So, fleeing to financial safe havens seemed like a no-brainer. But was it?
Retirement Savings: Time To Flee To Safe Havens?
Look what happened to the retirement savings of people who hung tough and stayed the course with whatever their asset allocation was in their 401(k) accounts and similar retirement savings plans.
By 2010, their accounts cumulatively had recovered. They were worth more than they were at the end of 2007.
Their 401(k) accounts were worth a cumulative $3.1 trillion by the end of 2010. That topped their $3 trillion value at the end of 2007, according to J.P. Morgan Asset Management.
Those savers didn’t take any special protective steps. Whatever asset allocation they had at the outset of the crisis, they stuck with, whether that was 100% stock funds or some mix of stocks, bonds and cash.
They did not go to all cash. They did not flee to bonds.
In contrast, the overall market did not regain its losses until March 2012.
Why Doesn’t Cashing Out Work Better?
Why did stay-the-course investors do better? Three factors enabled them to erase their losses faster than the overall market.
First, 97% of those stay-the-course investors kept contributing to their 401(k) accounts and similar retirement savings, J.P. Morgan says.
As a result, they benefited from dollar-cost averaging. When the market went down in 2008 and 2009, those investors were still contributing the same number of dollars to their 401(k) accounts.
With the market down, every $1 those investors contributed bought more shares of the mutual funds they held. When the market finally rebounded, those investors held extra shares, which boosted their account balances.
Second, by continuing to contribute the same dollar amounts, they also kept receiving matching contributions from their employers. Those, too, added shares to their accounts. Those additional shares further turbocharged their balances in the eventual rebound.
Sticking With Your Plan
Third, by and large they stuck with their investment game plans. More than 85% of them did not change their asset allocations. They did not tilt more to cash and bonds.
Staying the course matters because it is notoriously difficult to guess the right time to get out of the market initially and then get back in, especially with mutual funds.
“Mutual fund investors tend to wait too long to get out, because it’s human nature to not want to realize losses,” Samantha Azzarello, global market strategist on the J.P. Morgan Asset Management Global Market Insights Strategy Team, told IBD. “They also tend to wait too long to get back in. Even once a snapback begins, they’re waiting for the market to prove itself.”
Missing The Best Days Hurts Your Retirement Savings
And guessing wrong, even by just a little, is costly. If you stayed fully invested in an S&P 500 index fund Jan. 3, 2000, and Dec. 31, 2019, a $10,000 investment would have mushroomed into $32,421.
That’s after going through the dot-com bubble bust of 2000, the rising interest rates crash of late 2018 and the 2008-09 financial crisis, and the Great Recession.
But if you missed just the 10 best market days during those 20 years, your retirement savings balance on Dec. 31 would have been slashed to just $16,180.
Your average annual rate of return would have been less than half as good, just 2.44% vs. 6.06% if you had stayed the course.
Why Market Timing With Mutual Funds Is Hard
Why is market timing with mutual funds so difficult? Largely because the market’s best and worst days are often so close together. If you try to guess the right time to get out and then try to guess the best time to get back in, if you guess wrong and hesitate even a little, you’re likely to miss out on some of the market’s best days.
Over the more than 20 years from Jan. 3, 2000, through March 17, 2020, six of the best days occurred within a week of one of the worst 10 days.
The single best day of 2015 — Aug. 26 — was just two days after the worst day, Aug. 24, 2020.
Bottom-line lesson: Stick with whatever mix of stocks and bonds and cash your long-term retirement savings investment plan calls for. Don’t try to dart in and out of funds unless you know which indicators to watch.
How Much Does Market Timing With Funds Hurt?
How much damage does market timing with mutual funds cause? Research firm Dalbar compared how the market actually performed with how mutual fund investors’ accounts did. What it found was not pretty.
The damage was caused by investors’ trying to outsmart the market. They tried to dodge market declines and take advantage of market rallies. Instead, they did the opposite, often buying high and selling low.
Over the 30 years this past Dec. 31, investors in U.S. stock mutual funds trying to time the market’s ups and downs outsmarted themselves catastrophically. Those 30 years included some big up years. They also included the aftermath of the Crash of 1987, the Dot-Com bubble bursting and the financial crisis of 2008-2009 followed by the Great Recession.
Still, a buy-and-hold investor who held onto his S&P 500 index fund would have enjoyed a solid 9.96% average annual gain
The average stock fund investor? His return was barely half as good, a more modest 5.04% average annual gain, according to Dalbar.
How much is that in dollars? Suppose you are a typical worker in midcareer. Let’s say your 401(k) account is in a plan run by giant Fidelity Investments. You plan to retire in 22 years, at age 67. Meanwhile, you invest $11,100 a year, the average amount that a Fidelity 401(k) account holder kicks in, including his company match.
The average Fidelity 401(k) account balance for a 45-to-49-year-old was $104,000 as of March 31.
By the time you reach age 67, your balance with the stay-the-course mutual fund strategy hits a nice $1.8 million.
Your balance with the market timer’s 5.04% average annual return? A little more than $762,000.
That’s a mind boggling underperformance of $1.05 million. That’s a 138% underperformance. And we’re not talking about investing in exotic securities. You get the extra $1.05 million simply by sticking with an S&P 500 index fund.
When Cashing Out Is OK
Notice that we’re talking about do’s and don’ts with your mutual funds.
With your individual stocks, you buy, hold, add or sell based on the rules of a time-tested strategy that tells you when to get in and out of securities.
It’s also OK to go to cash — if you’re not already there — with the portion of your retirement savings that has a short time horizon.
That’s the part of your portfolio that you plan to use to pay for a specific goal in, say, two years or less. It can be a goal like that round-the-world trip you’re planning.
That money should be set aside in cash or stable investments that do not lose value amid market volatility. The same idea applies to longer-term savings that aren’t retirement related, like paying for your kids’ or grandkids’ current tuition.
The point is, it’s the portion of your portfolio that’s supposed to stay invested longer term, which typically means more than two years, that you should stay the course with. Even amid harsh market volatility.
The original article can be found here.