Protect Your Assets Best: Get out Now or Keep Your Money in Stocks?
With the S&P 500 up 24% year-to-date, on top of 18% in 2020, how high can it go? Should you take your money out before a crash wipes out a huge chunk of it, or stay in and hope for the best? Here's what I'm doing, which will let me profit from a market crash (without shorting the stock market).
With the S&P 500 up 24% year-to-date, on top of 18% in 2020, how high can it go?
Occasionally, you run into somebody doing something super-creative and cool.
It happened to me when I saw a cool video created by James Eagle, self-described “Investment writer, blogger, data junkie and entrepreneur,” which he captioned: “The Dow Jones is 125 years old. In its honor, I’ve put together this animated chart.”
Here it is:
Set to music, the video tracks the Dow Jones Industrial Average through 1500 consecutive monthly closes, calling out significant events such as the Great Depression, founding of various companies, and many recessions.
Here are my takeaways from the video:
- Over the long term, the stock market will make you money. A lot of it. If you’re invested.
- Once in a while, the market will take away money. A lot of it. If you’re invested. But if you stay in, Mr. Market will give you your money back. And more.
- Predicting which months Mr. Market will be generous and which ones he won’t is impossible.
Should I Get out of the Market Now, or Keep My Money in Stocks?
Neglecting a sharp bear market followed by an incredibly quick recovery in early 2020, the stock market is in a bull market that’s already longer than any in history.
With these facts in mind, you’d be forgiven if you’re feeling greed, expecting the market to keep shooting for the stars.
Conversely, you’d be forgiven if you’re feeling fear, waiting for the proverbial other shoe to drop.
So, should you take counsel of your fear or your greed?
What Does History Say About Staying Invested?
I’m sure you’ve seen at least one of those articles that talk up how your performance in the stock market tanks if you miss the best 10 days, the best 20, the best 30, etc.
In an article from Dec 31, 2020, the Motley Fool shows a table that details those for the 20 years from the start of 2000 to the end of 2020, or about 5040 trading days.
My initial reaction to this was, unsurprisingly, wow!
If you missed just over one half of one percent of trading days when the market had its best returns, your overall annualized return went from a smidge over 6%, to an annualized loss of 1.95%!
To put that in perspective, over a 20-year period, that would have moved you from more than tripling your money to losing a third of it!
And since nobody can predict which days will be best, it seems an open-and-shut case. A slam-dunk. Staying invested through thick-and-thin, boom-and-bust, is the way to go!
Well… My second reaction was a bit more nuanced.
If you miss out on the best trading days, wouldn’t it stand to reason you’d probably also sidestep the worst? And if you did, wouldn’t your returns be better than the Fool’s table implies?
Guess what? I wasn’t the first to have that thought.
According to an interesting report from Invesco, the real picture isn’t so cut-and-dried… (notice the pattern of my cliches?)
Their report shows what happens if you missed the 10 best days over an 82-year period, or about 20,660 trading days. Then, it shows what happens if you sidestepped the worst 10 days in that period. Then, most realistically, it shows what happens if you avoid both the best and the worst 10 days.
If you managed to miss out each and every one of the best 10 days — less than 0.05% of the trading days in the 82-year period covered (talk about bad timing!), your annualized returns would drop from 5.1% to 3.7%.
Stay in for those 10 days and magically sidestep the worst 10 days, and instead of losing 1.35% of annualized returns, you’d increase them by 1.40%.
In the realistic scenario that you sidestepped those 10 worst days, but then also missed the best 10 days (that usually happen around the same time), your annualized returns would be almost identical to staying invested all the time (< 0.1% difference per year)!
Over the course of a plausible 20-year investing timeline, your total return would be 1.7% better by accurately identifying when the market will do worst, and move your money fully out of the market, accepting that you’d also miss the best days.
Putting that in perspective, if you intend your portfolio to give you $50,000/year in retirement, this would give you an extra $80 a month.
Not bad, but is it worth the risk of managing to miss more great days than bad days?
I don’t think so.
How I Decide When to Pull My Money out of the Market, and Why I Changed It (a Bit)
Even if you look at the more nuanced data of stepping out of the market for both the best and the worst days, you neither gain nor lose too much.
This is why, in general, I’ve followed a simple rule about when to put my money into the market, and when to pull it out:
If I have extra money, I invest it. If I urgently need extra money, I sell investments.
Early this year, I diverged a bit from that simple rule.
My portfolio had just returned a spectacular 39.9% in 2020, more than double the S&P 500’s return, and more than 5× my somewhat conservative long-term projection of 7%/year.
My Portfolio Had a Spectacular 2020 — Now It’s Time to Change Winning Strategies
The time to play defense may be upon us; here’s why and how I’m doing it… (with an update on results to date) - themakingofamillionaire.com
Since my portfolio was almost 19% fatter than it would have been had I been invested in an S&P 500 index fund (as recommended by Warren Buffet), I simply took that extra money off the table by increasing my cash position from 10% to 30%.
Warren Buffet Recommends Index Investing — Really Best for Your Money?
Comparing actively managed mutual funds to low-cost index funds may surprise you… - medium.com
My Plan Now
Remember that video we started with?
I have no more idea than anyone else as to when (not if) the market will crash again.
Since I’m within a few years of my financial independence date, I prefer to not risk a massive market crash pushing that date a decade into the future. So I’ve mitigated that risk by setting aside that 30% in cash instead of 10%.
If the market crashes 50%, I’ll lose 35% of my portfolio instead of 45% (that I'd have lost if I had 90% in stocks). Then, I’ll move my cash back into the market, accelerating my personal recovery.
Here’s how it would work.
The following table shows how each dollar of my portfolio would fare through such a scenario, including the market recovering to its original level (which historically has taken between 2 and 3 years on average).
If we assume the market takes 3 years to recover to its original level, its annualized return would by definition be flat over those 3 years. But my personal return would be over 9%/year through that crash and recovery.
But what if the next crash happens 5 or 10 years from now?
I’ll still do the same.
If the market returns my assumed 7%/year average for the next 5 or 10 years, I’ll miss out on 6.4% of my overall possible returns (comparing 30% cash to 10%) over 5 years, or 12.4% over a decade. But how likely is it that the market will keep going up another 10 years?
One of my favorite sayings says, “The race is not always to the swift, nor the battle to the bold… but that’s the way to bet.”
So, yes, it’s possible the bull will continue running another decade, making it more than 2.3 times longer than the next-longest bull market, but that’s not the way I’d bet.
I’m fairly confident we’ll see a crash much sooner than the 2030s.
Either way, adding an assumed 3-year ride through a crash-and-recover following such a 5- or 10-year “steady-as-she-goes” period, I’d still come out 10.6% better over 8 years (1.27%/year), or 3.5% better over 13 years (0.27%/year).
“But what if the market shoots up over the next few years?” you might ask.
In that case, I’ll just reach my financial independence even faster than I would with a 7% annual return. You see, I care more about reaching my financial goal than I do about the bragging rights of beating the market.
One reader challenged the above thought process by asking how things would change if the market crashed 60% instead of 50% and took a decade to come back, rather than 2–3 years.
Though, as I pointed out to him, that length of recovery hasn’t happened (to the best of my admittedly imperfect knowledge) in almost 90 years, it was a good question.
I reran my numbers for the case he suggested, and here’s what would happen in his scenario.
These numbers don’t change with different recovery period lengths. What the length of recovery does change is the resulting annualized returns, which are:
- 3-year recovery: 13.2%/year
- 5-year recovery: 7.7%/year
- 10-year recovery: 3.8%/year
As you can see, increasing the assumed depth of the crash actually makes my eventual returns higher for a given length of recovery period. A 50% crash with a 3-year recovery would result in a 9% annualized personal return, while a 60% crash with the same 3-year recovery would yield 13.2%/year, almost half again as much.
Assuming a longer time before the market recovers reduces the annualized returns, and also means I’d have to wait longer before starting to take money out (though I could start before the market recovers fully if I’m willing to accept a lower return than what I’d get by waiting).
The Bottom Line
If I had many decades until financial independence, I’d just leave my money in the market, ignoring recent performance, and especially ignoring all the so-called market mavens and talking heads.
With just a few years left, it makes more sense for me to be more conservative. That’s why I moved my excess return from last year off the table and into cash.
When, not if, the market crashes, I’ll be in position move that cash back in when the market is low, accelerating my personal recovery and allowing me to benefit from a big positive personal return during a time when the overall market manages to just break even.
About the Author
Opher Ganel has set up several successful small businesses, including a consulting practice supporting NASA and government contractors. His most recent venture is a financial strategy service for independent professionals (where you can sign up for his biweekly newsletter and get some nifty free PDFs). You can also connect with him by following him here or on his Medium publication, Financial Strategy.
This article is intended for informational purposes only, and should not be considered financial or investment advice. You should consult a financial professional before making any major financial decisions.
Consultant | physicist | systems engineer | writer | financial strategist | avid reader | amateur photographer & artist | support my writing (and read much more financial insight) here ➜ https://opher-ganel.medium.com/membership