Investing in stocks – Don’t be rhinophobic
Rhinophobia is the disease of investors: the fear of holding cash. The rhinophobic feels that all his “stock money” must be fully invested at all times.
Let’s say you’re an individual investor and you’ve decided on an asset allocation of 60% stocks and 40% bonds. So if your total investable money is $100,000, then $60,000 is your “money in stock.”
Question: Does all of your stock money always have to be invested in stocks? If you answer “Yes”, you have rhinophobia and you should see a doctor. Or just read the rest of this article. Because the best answer, the one most likely to keep you financially healthy, is “No.”
It is an unfortunate myth in the stock investing industry, including many experts and mutual funds, that the most intelligent investors are fully invested at all times. In other words, they invest the cash as soon as they get their hands on it, they “never sell”, and if they do, they reinvest the profits immediately. This myth is obviously a corollary of a dogmatic buy-and-hold ideology.
The reason the myth is unfortunate is that it causes people to lose money. It’s why so many investors who were fully invested when the market peaked in early 2000 stayed fully invested as the market tumbled for the next three years, instead of getting out until the decline stopped. It’s also why many of them will remain fully invested the next time a bubble bursts or a bear market catches up with them.
Even those perceived as the most conservative stock investors—”value” investors with a buy-and-hold inclination—in fact time their moves to avoid rhinophobia. They do this when they decide not to buy a stock because it doesn’t meet their valuation criteria (“We’re waiting for a better price”), or to sell a stock because it has met their target price (“We think this stock has had its run: we’re very disciplined about selling when a stock hits our target price.”) They’re actually practicing a form of (cover your kids’ eyes here) timing.
If you ask the average informed investor what Warren Buffett’s investment style is, they are likely to say, “Buffett is a value investor with a buy-and-hold approach.” And that would be generally correct. But Buffett avoids rhinophobia. Here’s what he said in his 2003 annual letter to Berkshire Hathaway shareholders: “Sitting is not fun. But occasionally, successful investing requires inactivity.” As recently as May 2006, Forbes magazine reported that “Buffett, to the chagrin of investors, is sitting on a mountain of cash and bonds (50% of the market value of Berkshire ) waiting for better opportunities.”
Why would that bother Berkshire Hathaway shareholders? Buffett obviously knows what he’s doing, judging by his track record over the last five decades. He is, after all, the richest person in the world whose wealth came entirely from investing. What “angry” stockholders are forgetting, and he isn’t, is that rule #1 in stock investing is: “Don’t lose money.” your “stock money” in cash, not stock.
If, for whatever reason, you sell a stock, there may be times when you don’t want to reinvest the money right away. Rather, you may want to keep it in cash for a while, until conditions improve. The same if you come into possession of new money. Don’t be afraid not to invest. If you can’t find enough good places for your “stock money,” let it sit in cash until valuations improve, market conditions change, or you discover a promising new investment opportunity.
In other words, your strategy as a sensible stock investor must include a cash strategy. To manage a stock portfolio sensibly, cash is a legitimate parking spot for “stock money” when:
o You are in a generally declining or sideways market; nothing seems to be working right.
o You are in a deflating bubble, like the deflation of the 1990s bubble between 2000 and 2002.
o Great investment opportunities in shares are not appreciated.
o It is in a protection mode.
When you’re an individual investor, it’s like running your own small business or mutual fund. You want to execute it intelligently. Now, the great companies you invest in don’t ignore time in running their own businesses. They don’t mindlessly forge ahead with ruthless product introductions, marketing campaigns, and acquisitions, regardless of the economy, interest rates, and conditions in their own industry. Sometimes they hold on to their investable cash (retained earnings) waiting for good opportunities. They study their markets, identify trends and changes in their industry and adjust their actions through a continuous process of strategic evaluation. They manage risks in this way.
Expect no less from yourself as an investor. Why would you passively hold on to all your stocks during a prolonged period of obvious market decline, like 2000-2002? Has no sense. It is rhinophobia, a disease that will make you poorer.
Don’t be rhinophobic. The return on your investment will be much better if you get vaccinated against this disease. Do it with caution. Be willing to invest new money when you identify a promising opportunity, but don’t feel the need to invest all the time. Cash is fine when good opportunities are not readily apparent.