When investors are fearful, they often run to cash to try to protect themselves. However, most investors are fearful at the wrong times, so often they protect themselves from gains. Josh Brown of The Reformed Broker wrote such a good piece on this that I just had to include his awesome checklist here!
I went to cash because (please check one):
2. The Taper
4. Debt Ceiling
5. Egypt Revolution
6. Portuguese Bond Auctions
7. US Elections
8. Syria Threat
10. Chinese GDP
11. London Whale
12. High Frequency Trading
13. Nasdaq Freeze
15. Marc Faber web video appearance on cnbc.com
16. Larry Summers
17. Low Volume
18. CAPE Valuation
19. Hindenburg Omen
20. Death Cross
21. Other (please explain): _____________
I don’t think Mr. Brown is necessarily suggesting that cash is never a good idea, but he is poking a little fun at the many excuses investors use to raise cash to make themselves feel better.
If emotional investing is not a good idea, what should investors be doing? While this is not an exhaustive list, here are some thoughts that might make raising cash a little less random—including some other ways to deal with portfolio volatility.
- consider that good diversification is one way to deal with occasional bouts of portfolio discomfort. We often talk about diversifying by volatility, by asset class, and by strategy.
- consider the use of a long-term moving average to raise cash on individual securities or the overall market. Using a moving average is not likely to help your returns, but it typically reduces volatility.
- consider making no major portfolio changes when the market is within 8-10% of its recent high. 8-10% fluctuations are normal, fairly frequent, and shouldn’t warrant wholesale portfolio changes.
- consider using relative performance when it is time to reduce your exposure. In other words, sell what’s been performing the worst (instead of hoping it will rebound) and hold on to the strongest performers.
There’s no perfect way to manage a portfolio. Every investor makes plenty of mistakes along the way, but minimizing the negative effects of those mistakes can really help in the long run.