The High Cost of Sitting in Cash

One of the biggest mistakes I see people make with their money isn’t investing haphazardly. It’s the opposite. They’re too conservative. Convinced the market is overvalued and due for a correction, these people stay on the sidelines, waiting to buy back in. They may have hundreds of thousands (or millions) of dollars sitting in cash and have done so for years, missing out on exceptional market gains. I even know someone who’s been shorting stocks for the past 15 years (yes, really).

This behavior can obviously be financially devastating. Compounded investment gains over time is clearly the key to achieving financial freedom. If you’re sitting on the sidelines waiting for an entry point, you’re simply not participating, and the opportunity cost is killing your retirement plan. 

This situation happens far more than you think. A surprisingly large number of new clients that we have onboarded over the past few years have been in this situation, either due to fear or ignorance. Our job is to help our clients break through this barrier. 

Many trace this caution back to the 2008 Great Financial Crisis. Jobs disappeared, home values plummeted, and household wealth was halved. That pain left a lasting scar.

I didn’t just hear about this fear—I experienced its origin firsthand.

Welcome to Finance

My first job in wealth management began in January 2008 at Merrill Lynch in Beverly Hills. I was young, eager, and, to be honest, had little idea how markets or the economy truly worked—let alone how to invest other people’s money. But I was about to get a crash course in both, as a black swan event for the ages unfolded right in front of me.

(Side note: this is a dirty secret of the wealth management industry. There’s virtually no formal training. Someone can study for a few months, pass the Series 65, and legally manage client portfolios and provide financial advice—no degree or advanced training is required. If you can sell, you can become a financial advisor. The barrier to entry in this industry is apallingly low, and this is why you see so many unqualified advisors out there. I don’t like to badmouth my industry, but it’s true. At Bull Oak, we do things differently: we hire top‑tier talent and train our advisors for years before they begin to give advice.)

By March 2008, Wall Street was starting to feel the impact of falling home prices and overleveraged consumers. Bear Stearns collapsed. Countrywide Financial was bailed out. The Federal Reserve cut interest rates. It also allowed Fannie Mae and Freddie Mac to purchase $200B in subprime mortgages from banks. The idea was that this would contain the crisis. 

It didn’t. 

By September 2008, IndyMac had failed, Lehman Brothers had gone bankrupt, and the Federal Reserve had taken over AIG. The FDIC seized Washington Mutual. MUFG made a sizable (rescue) investment in Morgan Stanley. Berkshire Hathaway made a $5B investment in Goldman Sachs (genius move by Warren Buffett, BTW).

By March 2009, the S&P 500 had dropped 57% from its previous high in October 2007. Home prices fell by over 30% from its last peak. In some places, like Las Vegas, home prices fell by over 60%.

It was a mess. And it took a while to recover. But it did eventually recover. Unlike other recessions that rebound quickly, this one took years because American households needed time to deleverage and rebuild.

The US economy peaked in Q4 2007 and bottomed out in Q2 2009. It took 15 quarters (3.75 years) before the economy returned to its previous cycle peak. 

I share this because the Great Recession scarred nearly everyone participating in the US economy. This was the closest we came to experiencing a repeat of the Great Depression. If you are over 40 years old, then chances are really high that you remember the impact of this recession. And there is a great chance that this impact still shapes your market behavior today.

The Deadly Sin: Fear

When it comes to investing, there are 4 Deadly Sins to be aware of: ignorance, greed, fear, and hope. What I’m describing is fear—the fear of another 2008-style crash.

Because they are fearful of experiencing another loss like this, they rationalize that it is wiser to preserve their capital rather than risk it. In some situations, this might be true, especially if their time horizon is short. However, for most investors, it’s a terrible mistake. The opportunity cost of missing out on investment gains will far outweigh any temporary losses incurred during a market downturn. 

For example, let’s say that you have a $3,000,000 portfolio. You decide to sell your stocks and put it all in cash because you think a market downturn is imminent. And let’s say that you got lucky and you happen to be right. We experience a recession, and the market falls by 35% (a typical recession and a typical downturn). You pat yourself on the back because you just saved yourself $1 million! Your $3 million portfolio could’ve turned into a $2 million portfolio, but you avoided this. 

You also rationalize that once the economy is back on solid footing, you plan to reinvest your money. However, you soon realize that the market moves ahead of the economy. Stocks are a forward-looking indicator, while the economy is a lagging indicator, meaning that by the time the economy feels more stable, it’s too late. The market has more than fully recovered. 

Now, you’re in a difficult situation. Do you buy back in at even higher prices than what you sold out of, or do you wait for a market pullback?

And this right here is the trap that so many investors get themselves into. Most people with cash on the sidelines got there in the first place because of fear. And more often than not, they also realize that the market has continued to march higher, leaving them behind, but they are not sure of how to get back in.

Time in vs. Timing

The old adage, “Time in the market beats timing the market,” has been proven true over the years. No one can reasonably and consistently predict all of the peaks and valleys of the market and trade around them. There is a very, very low probability of success in playing this game.

Buy the market, stay invested through thick and thin, and you will find that this is a far better (and richer) strategy. If you are working and saving, dollar-cost averaging (DCA) into the market is an even more effective wealth-building strategy. And, if you’re in the position to do so, buying even more stocks when the market has dipped is the ultimate cherry on top. 

Make Money Work For You

The whole point of working, saving, and investing is to accumulate wealth to a point where it begins to work in an effort to achieve financial freedom. If you let your fear of market downturns keep you from actually investing your money, you are severely hamstringing your chances of success. 

It is difficult to separate your emotions from your money. But if you can get past this critical (and common) pitfall, you are already halfway there. 

Let us know if we can help.

Ryan A. Hughes

Ryan is the founder of Bull Oak, a financial advisor in San Diego. He’s been listed in InvestmentNews 40Under40 and his firm has been named one of the fastest-growing by Wealth Management Magazine.