Recently we’ve enjoyed a bull market with stocks nearing an all-time high. The Standard & Poor 500 Index is up more than 300 percent from its low level of 2009! Investors are asking: Should I be in or out?
While some long-term investors are celebrating, others are wondering if they should pull out now before the market takes a nosedive. Does that sound like you? Before you make a hasty exit, you better be prepared to face the potential repercussions!
Pulling out of the stock market – even temporarily – presents its own set of risks. Here are three questions you’ll need to consider prior to bidding the stock market adieu!
Question #1: Where to Stash My Cash?
If you sell your stock, you have a bunch of cash. Now the big question is what to do with it. One option is to keep it liquid at your bank. Banks are safer than the stock market, right? Yes, but you’ll be lucky to get even a 1-percent return on your money from the interest you’ll receive. If you need growth, banks are not a great place to park your money for the long-term.
Here’s an even more compelling reason against banking your money: Inflation is running around 2 percent per year. If your cash is earning less than 1 percent interest, you’re losing "real" money each year.
What if you invest your cash in the bond market? Currently the yield on the Barclays Aggregate Bond Index is 2.24 percent. That’s a bigger return compared to putting your money in the bank, but not by much!
Bottom line: In this low interest-rate environment, there are no obvious places to park your cash and expect a decent return.
Question #2: When to Return to the Market?
When you decide to temporarily exit the stock market, you’re creating two important decision points – when to exit and when to return. Get either decision wrong and you’ll end up with a significant headache! The issue that generally gets the least upfront attention is when to return. It’s also the one that can have huge repercussions down the road.
Let’s use 2016 as an example of what can happen when you reenter the stock market. During the first six weeks of the year, the S&P 500 Index dropped almost 12 percent. Many experts feared the U.S. economy was headed for a recession. Let’s assume you got out before the market dropped. Lucky you! Now you have to decide when to get back in. What happened during the rest of 2016? The S&P 500 gained more than 22-percent from that low point at the beginning of the year.
- If the market soared before you returned, you missed out. Meanwhile, investors who stayed the course reaped significant gains that will give them a cushion to soften the next downturn.
- If you returned while the S&P was on the rise, you made some gains. Although, unlike those who stayed the course, you didn’t receive the full benefit. Consequently, when the market drops, you won’t have as big a cushion to fall back on.
Bottom line: The fear of losing money is a huge barrier for investors. If the market goes up, the longer you wait the more you stand to lose. If the market goes down, waiting is a virtue. Unfortunately, timing the market correctly is nearly impossible. Sticking to your long-term investment strategy will generally pay off.
Question #3: How to Supplement Lower Returns?
Many people exit the stock market because they think it’s too risky. It’s true that the stock market has more risk than a bank account or diversified bond portfolio, but it also has greater growth potential. And that shouldn’t be ignored!
If you exit the stock market at the wrong time or stay out of it for an extended period, you’ll need to reevaluate how this will impact your long-term goals. If your portfolio return is lower than initially planned, you may need to save more to reach your goals. If saving more isn’t an option, be sure to project your future financial situation in order to have realistic expectations.
Bottom line: If your investment portfolio does not achieve the return expected, you’ll need to make up for those lower returns to keep your financial goals on track.
Before you pull the trigger and exit the stock market, consider your long-term financial strategy. If growth is important, have a plan for re-investing and saving that will allow you to reach your future financial goals.
Ryan Collier is the Director of Investment Management with Bedel Financial Consulting Inc., a wealth management firm located in Indianapolis. For more information, visit their website at bedelfinancial.com or email Ryan.