As the stock market sags amid investor fears about coronavirus, mutual fund shareholders wonder how to avoid becoming collateral damage. Is cashing out of stocks and stock funds a smart way to protect their investments? Or should shareholders stay the course, stay fully invested?
The answer depends on which segment of your portfolio you’re asking about. There’s one answer for the segment of your portfolio that you rely on for money to pay current and near-term retirement expenses. Call that the spending bucket portion of your portfolio.
For that retirement spending bucket portion, park your money in either cash or short-duration bond funds, whose value changes much less than stock mutual funds do amid market volatility.
We talk about how to do that in another IBD report.
Coronavirus Stock Market Crash Survival Guide
- 1 Cashing Out Of Stock Mutual Funds In A Market Crash: Smart Or Not?
- 2 Bargain Bin
- 3 How This Mess Began
- 4 Stay The Course With Long-Term Funds
- 5 Sell Low, Buy High?
- 6 Cashing Out Can Cost You The Market’s Best Days
- 7 Market Rallies Start Unexpectedly
- 8 Missing The Best Days Is Easy
- 9 The Opposite Of Cashing Out
Cashing Out Of Stock Mutual Funds In A Market Crash: Smart Or Not?
There’s another, totally different answer for the segment of your portfolio whose job it is to keep growing faster than inflation. Call that the long-term growth portion of your portfolio.
That’s your entire portfolio if you’re young and more than about two years away from retirement. If you’re within two years of retirement or already retired, it’s likely still the bulk of your portfolio.
And that’s what this report is all about: how to handle the long-term growth segment of your portfolio during a market crunch like the current Covid-19 virus-fueled market retreat.
In fact, for the long-term growth segment of your portfolio, the market selloff can provide a special bargain-buying opportunity that you’ll benefit from in the long run — if your stomach can handle the volatility in the short run, and if you can afford to trim your take-home pay temporarily.
More about this special opportunity later in this report, after we explain who should stay the course with stock mutual funds rather than cashing out.
How This Mess Began
The Dow Jones Industrial Average officially dropped to bear market status on March 12, trading more than 20% off its Feb. 12 high.
So the coronavirus market crash now forces shareholders to make a classic strategic choice. While the market melts, are you better off cashing out of stock fund shares and seeking safe havens in cash and bonds? Or is it better to stay in your stock funds and wait for the market to rebound?
And people do react to headlines. China first reported that authorities were treating cases of coronavirus on Dec. 31. In January — although it is hard to say how much is due just to coronavirus-impact fears — shareholders yanked a net $39.2 billion from long-term stock mutual funds in the U.S., according to the Investment Company Institute. That was more than calendar 2019’s average monthly net outflow of $30.2 billion.
After subsiding in February, estimated net long-term stock fund outflows in early March — as coronavirus case reports and alarm grew in the U.S. — jumped roughly 68% vs. the prior month.
And remember, we’re talking about the mutual funds portion of your portfolio.
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.
Are you a newcomer to investing who wants to buff up your stock investing skills? Check out this guide for stock market beginners.
Stay The Course With Long-Term Funds
With your mutual funds devoted to long-term growth, experts advise: stay the course.
You may ask, Why? Why leave money in mutual funds that lose value in a downturn?
The answer is that individual mutual fund shareholders rarely, if ever, get out of the market near its top. And they rarely, if ever, get back into the market at its bottom.
For instance, in the 10 years ended Dec. 31, 2015, the broad stock market in the form of the S&P 500 rose 7.31% on average each year. But by flitting into and out of the market in reaction to market ups and downs, the typical shareholder in U.S. stock mutual funds gained just 4.23% each year on average, according to research firm Dalbar.
It’s like expecting to win a road race despite dropping out. It can’t be done.
Sell Low, Buy High?
Instead, time and again shareholders end up selling low — then buying high after missing the often explosive start to a rally.
“Mutual fund investors tend to wait too long to get out, because it’s human nature to not want to realize losses,” said Samantha Azzarello, global market strategist on the J.P. Morgan Asset Management Global Market Insights Strategy Team. “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.”
Meanwhile, if you simply stay put, stay invested, you benefit from the market’s remarkable history.
After all, the market has recovered from every downturn.
And that includes the Great Depression, World War II and the Financial Crisis of 2008-2009.
Cashing Out Can Cost You The Market’s Best Days
The trouble with cashing out or seeking a safe haven in bonds is that people tend to get out at the wrong time and get back in at the wrong time.
You’re likely to miss the typically unpredictable starts of each new run up in the market. Those tend to be among the market’s best days.
The price for missing out is that your total returns suffer.
Market Rallies Start Unexpectedly
Look what happened if you had invested $10,000 in the S&P 500 between the start of the year 2000 and last Dec. 31. If you stayed put, remaining fully invested through the market’s ups and downs during those 20 years, your average annual return was 6.06%. Your nest egg would have ballooned into $32,421.
But if you got cold feet, cashing out when the market got rocky, what happened? If you didn’t get back in soon enough to benefit from rallies after various pullbacks, and you missed just the 10 best market days during that 20-year period, your average yearly return got slashed by more than half to just 2.44%, J.P. Morgan Asset Management calculates. Your end balance would have been a far more modest $20,030.
The more best days that you miss, the worse your portfolio’s investment returns would have been.
If you missed just the 20 best market days, your rate of return would have shrunk to little more than break-even, a mere 0.08% average annual gain. Your $10,000 would have turned into $10,167.
If you missed the 30 best days, your return would have been negative. You would have lost money. Your $10,000 would have shrunk to $6,749.
Is that a price you’d be willing to pay to “protect” your money?
Missing The Best Days Is Easy
And it’s all too easy to miss the best days after cashing out. Six of the best 10 market days occurred within two weeks of the 10 worst days from 2000 and 2019.
The single best day of 2015 — Aug. 26 — was just two days after the worst day, Aug. 24.
But mutual fund shareholders tend to still be on the sidelines when those rallies make their explosive starts. “Big amounts of institutional money lead to quick snapbacks,” Azzarello said. “But individual shareholders tend to still be out of the market.”
Hiding on the sidelines feels safe. It ends up being costly.
The Opposite Of Cashing Out
Staying fully invested in the long-term growth portion of your mutual funds portfolio not only enables you to avoid missing out on big market rally days. It also provides you with a big positive benefit.
During a selloff, you are buying shares in funds you’ve already decided you like for the long run at lower shares prices. That means you’re buying more shares, if you keep investing the same dollar amounts – and that’s what you’d do unless you went out of your way to cut the size of your contributions.
“Once the market starts to rally, this will magnify your gains in the rally because you own more shares than you would have if the market had not pulled back,” Azzarello said. “This effect is known as dollar-cost averaging.”
That is the special opportunity we referred to early in this report.
In fact, you can boost the benefit of dollar-cost averaging even more if you increase the dollar amount of your 401(k) contributions. “It is definitely something to consider if you can afford to decrease your take-home pay by that amount and if your risk tolerance will allow it,” Azzarello said. “Remember, the market could go down even more or stay down a long time.”
A version of this story was first published March 7.
Follow Paul Katzeff on Twitter at @IBD_PKatzeff for tips about personal finance and strategies of the best mutual funds.
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