I find myself raising 10%-15% cash in the taxable joint brokerage account my wife and I use to pay for much of our living expenses. No change in our fully invested stance in our IRAs or 401ks, just the taxable account.
Thirty years of professional training and experience tell me this is always a mistake. But I’m doing it anyway.
why pros don’t do this
The easy answer is that pros typically can’t. Their contracts with pension funds routinely require that the managers they hire remain fully invested. The idea is that the pension fund and its consultants control the asset allocation (thereby justifying paying themselves the big bucks) and parcel out various pieces of the overall portfolio to specialists. If managers stray from the asset classes where they’re experts they risk mucking up the overall asset allocation strategy.
Although mutual fund charters usually offer much more leeway, the manager will be pilloried if he raises a large amount of cash and the market goes up.
–to make a significant difference in performance, you have to raise a ton of cash–30%-40% of the portfolio at least. This turns the portfolio into a Las Vegas-like all-or-nothing bet.
–I’ve never met an equity professional who’s any good at timing the market. People tend to either understand either market bottoms very well–when to invest aggressively–or market tops–when to become defensive–but not both. So they either raise cash much too early, or they get that timing right and never put the money back to work. In either case, the cash-raising exercise tends to backfire.
This doesn’t mean there aren’t any successful market timers. I just don’t know, or know of, any. And I’ve seen lots of managers punch big holes in the bottom of their performance boats by trying their hand.
–the desire to raise cash invariably comes at times of stress and high emotion. Emotional decisions in investing are almost always bad ones.
what pros do (or should do) instead
Make the portfolio less aggressive, so it will perform better in a downturn. Eliminate speculative, smaller-cap, or highly economically sensitive names.
Look harder for new names. If everything in the industries you feel most comfortable in looks too expensive, broaden your scope to include other sectors.
Go on vacation.
If you absolutely have to sell something (for your own emotional well-being), do it in small enough size that it won’t do much damage.
why I’m ignoring my own advice
–low interest rates have forced me into a very high equity allocation
–in this account, I’m more interested in having money on hand to pay bills than in beating the S&P. So I’m willing to accept underperformance.
–history says that stocks go sideways to up during periods when the Fed is removing emergency money stimulus from the economy. I think this should hold true again. On the other hand, while stocks appear reasonably priced to me, the size of the interest rate raise now underway is about double the normal size. So there is an uncharted waters aspect to this Fed move.
Also, the tone of the market seems to me to be increasingly set by short-term traders who don’t have the skill or temperament needed to analyze economic fundamentals. Their behavior is harder to predict with confidence–just look at what’s going on in Japan.