Why acting on the impulse can have a negative impact on your portfolio


Taking your money out of the market and putting it into cash can be tempting when the market takes a downturn. Vanguard investing experts Kahlilah Dowe and Don Bennyhoff explain why acting on the impulse to put all of your money in cash can have a negative impact on your portfolio.

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Notes:
For more information about Vanguard funds, visit vanguard.com, or call 877-662-7447, to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information are contained in the prospectus; read and consider it carefully before investing.

All investing is subject to risk, including the possible loss of the money you invest. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

Diversification does not ensure a profit or protect against a loss.

This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.

Advisory services are provided by Vanguard Advisers, Inc. (VAI), and registered investment advisor.


TRANSCRIPT

Matt Benchener: And we have another live question that’s come in from Ronald who asks, “When stocks are continuously declining and the bond market is not good, is there any real problem in balancing to all cash?” And so I think that’s the question, and then he attached a statement to it. “If you are an astute investor, you can always buy back in when the market starts to steadily increase.” So Ronald’s kind of saying, “Well, the market’s declining, the bond market’s not looking so good,” I presume, because interest rates might be rising at some point. Maybe that’s what he’s saying. So what’s wrong with going to all cash and then getting back in when the environment improves?

Kahlilah Dowe: It’s easier said than done. It’s very difficult to do, and really it’s an emotional response to what’s happening in the market. And I would say keep in mind that part of the normal cycle of the stock market is to go up and to go down, and that’s not unusual. And I don’t think that it’s a signal to investors that they need to abandon their investment strategy. We do look to the bonds as a way to minimize or lower the volatility of the overall portfolio, and many investors are looking at the bond market and saying, “Is that still the case? Should I still look to bonds to do that given, like you said, the fact that interest rates having started going up and may continue to.” And when I speak with investors who have that concern, my response is yes. And I think what we’re seeing right now is a prime example of that where stocks across the board globally are down about 7% and bonds are still in positive territory.* Now I could look at that and say, “Well that’s not good for bonds. On average they return close to 5%.”** And, again, I would say, again that cycle where we won’t always see those averages. But the most important thing is that if you have both stocks and bonds, I would be surprised if you were down as much as the overall market. To his point, you could sell everything and move to cash. If it’s a long-term portfolio, so this is money that you’re not going to need for many years, you would quickly see that cash really isn’t a good option either because it’s not yielding anything at all. And then the greater problem is knowing when do I get back into the market? And in my experience, investors who abandon their investment strategies, again, tend to be more emotional investors and are unlikely to get back into the market as it goes down. Most of the time what I see is that they’re waiting until it goes back up. And they say, “Well, things look better now and things feel better, and so I’m going to go back into the market.” And I think it’s that pattern of trying to decide when do I leave the market and when do I go back in that really erodes wealth over time. Right? It’s not getting that right. And it’s difficult to do. It’s not so much a decline in the stock market. So I just want to be clear, when we think about eroding wealth, the declines in the stock market, the normal declines that we see, I don’t think that’s the risk that investors face, assuming that you’re invested properly. It’s trying to time the market that really presents that risk of eroding your wealth over time.

Matt Benchener: I recall, to your point, in 2008, 2009, you know, as bad as things have gotten at least in many of our lifetimes, and had you sold everything out at the bottom, which would have been really hard to time, and then held on until there are really clear signs in the market that things were going to get better, you would have missed out on a lot of returns. And by contrast, we had many clients across all of our businesses who held on through that cycle and more than recovered their losses. And I actually think, if I recall correctly, outperformed, had we just had a steady 5%, you know, return from 2009 to 2013–14. So it’s just really hard to know, to your point. And there’s risk in missing out when things do get better.

Kahlilah Dowe: Right, and I know he said an astute investor. And not to take anything away from astute investors, but I really don’t think it’s a matter of, like, knowledge. It’s just even the greatest and the brightest, I mean even though here at Vanguard we are the first to say that we don’t know when the bottom is going to, you know, when it’s going to be the bottom or the top of the market. I don’t think investors need to know that, though, in order to be successful in investing. You don’t have to get it quite right where you go in at the bottom or sell at the top. I think it adds more risk to the portfolio and, ultimately, I’d be surprised to see if it made for greater returns over the long term.

Matt Benchener: Don, anything you wanted to add on that?

Don Bennyhoff: No, I mean, I would want to reemphasize or emphasize a point that Kahlilah made in terms of it’s not about knowledge. Investing is really tough. When you look at, just say, just shift our focus to the track record of active managers, and we love our active managers and we know what they do and how well they do it. But we know that they don’t outperform their benchmark or their peer group each and every year. And that’s because when you look at the task at hand of trying to get an advantage over the peers or the market, which we kind of feel is like a passive aspect. It’s something else when it’s actually someone else. So if I think that Apple is overvalued and I want to sell, someone on the other side of my trade is buying Apple for the reason that they don’t think the same way I do; they have an opposite opinion. And the person on the other side of the trade these days is much more likely to be a highly skilled, highly trained, highly informed investor compared to the other side of the trade, which could be exactly the same. It’s one professional competing against another. It’s not professionals competing against the uninformed or the emotional investors, the mom and pops, if you will. And I think that all gets overlooked. When you look at the track record of active managers, as great a track record as many of them have, they rarely outperform consistently each and every year because it’s such a difficult task to outperform a very highly skilled other side of the trade, their competition.

*Source: Wilshire 5000 Total Market Index YTD as of February 3, 2016.

**Source: References to historical averages of bond returns are represented by S&P High Grade Corporate Index from 1926 to 1968, Citigroup High Grade Index from 1969 to 1972, Lehman Brothers U.S. Long Credit AA Index from 1973 to 1975, the Barclays U.S. Aggregate Bond Index from 1976 through 2009 and the Barclays U.S. Aggregate Float Adjusted Bond Index thereafter.

Important information
For more information about Vanguard funds, visit vanguard.com, or call 877-662-7447, to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information are contained in the prospectus; read and consider it carefully before investing.

All investing is subject to risk, including the possible loss of the money you invest. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

Diversification does not ensure a profit or protect against a loss.

Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer’s ability to make payments.

Past performance is no guarantee of future results.

This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.

Advisory services are provided by Vanguard Advisers, Inc. (VAI), and registered investment advisor.

© 2016 The Vanguard Group Inc. All rights reserved. Vanguard Marketing Corporation, Distributor.