Navigating Market Corrections and the Temptation of Cash Amidst Short-Term Volatility

December 01, 2023

What a difference a few weeks can make in the stock market! If you opened the newspaper or tuned into the news on Saturday, October 28th, you likely would have read or heard the S&P 500 had entered correction territory when the markets closed that Friday. A stock market correction is defined as a decline of at least 10% from its most recent peak. Just so happens on October 27th, the S&P 500 had fallen 10.3% from its recent high on July 31st. The financial media loves to highlight periods like this as the drama of bad news often generates more clicks and readership than that of good news. It is why so many of the financial outlets focus on what could go wrong in the financial markets and economy than what could go right to turn things around.

It is human nature for these declines to give investors pause on investing cash they may have on the sidelines or to want to reduce their portfolio exposure to stocks, especially at a time when the relatively safe yield that one can get in cash-like instruments such as money market funds and 6-month certificates of deposit is 5%. That’s why it is important to identify how much of your assets you need to meet your short-term, intermediate-term and long-term needs. If you move assets meant for long-term goals to short-term instruments like cash during periods of market volatility, history has shown that you often leave return on the table over the next 12 months. Dating back to July of 1926, when US large cap stocks experienced a 10% market decline, on average the next 12 months US large cap stocks have delivered a return of 12.5%. Returns get even better the further you look out in time from the 10% decline. The average 3-year cumulative return has been 34.5% and the average 5-year cumulative return has been 68.8%.

So far, this time around is no exception. The week following October 27th saw the S&P 500 climb 5.3%, delivering its best week of return for 2023. Further, since the market close on October 27th, 12 out of 16 days have seen the S&P 500 deliver positive returns, resulting in a total return of 9.6% through market close on November 17th.  While this is a very short timeframe, it is a good reminder to fight the urge to go to cash, or let your long-term assets sit on the sidelines in cash, when the stock market hasn’t performed well recently.

It is getting to be the time of year when the various Wall Street pundits and strategists begin to publish their 2024 market outlooks. As they do, enjoy reading their opinions and prognostications, but do so more for entertainment and enjoyment and less for informing your investment allocation. No one has the crystal ball that will accurately predict where the stock market or interest rates will move over the next 12 months. When it comes to the allocation of your assets between stocks, bonds, and cash, remember to let the time horizon for when you need your assets, along with your ability to withstand volatility in the markets, dictate how much you invest in each asset class, not the opinion or prediction of a so-called market expert.