When the road gets rocky, should we dash to cash?
During periods of falling or volatile markets, our instincts may tell us to switch to the perceived safety of cash and get back into shares after the sharemarket has risen.
While this is an understandable emotional response to uncertainty, the ‘dash to cash’ can ultimately be wealth destroying and present serious challenges for investors.
When investors sell after markets have fallen they effectively crystallise their losses, which until then may have been just a paper loss. Wealth destruction is compounded if the investor remains in cash for too long, and misses out on any market revival that takes place.
Once the move to cash is made, investors then need to make another very crucial decision. When should they move back into the markets and resurrect their long term investment strategy?
They may re-enter the markets only to be caught in another downward spiral. Or, they could re-enter after the market has recovered and miss what may have been a sharp uptrend.
Chopping and changing strategies, including trying to run from market losses by moving funds in and out of cash, means you may not achieve your financial goals.
The risks of cash
It’s also important to remember that cash, like any asset class, has its own set of risks and may even work against you in the long run.
History shows us cash has the lowest expected real (after-inflation) return in the long-run compared with a diversified strategy.
Often perceived as a ‘risk free’ asset, the opportunity for real capital growth with cash is negligible. Furthermore a significant proportion of the return from cash gets eroded by inflation over time. And any interest earned is fully taxed at the marginal rate with no capital gains tax concessions available.
The relationship between financial planners and their clients has many aspects but perhaps the most important is behaviour management. Just as investment markets go through different stages so too do the emotions of investors.
While it may surprise many clients, the challenge a good financial planner faces is not in the choices of stocks, or the balancing of portfolios. It’s helping clients see past the emotion of the investment cycle, preventing them from making decisions based on emotional responses which can ultimately be wealth destroying.
That’s why your financial planner is the best person to help you see through the hype and concentrate on what really matters by ensuring you meet your long-term wealth creation goals.