I received an interesting question recently. The answer may be instructive to many. A retired man asked:
I am 78 years old and count on my investments to help pay my living expenses. Most of my money is in stocks. With the market up so much, do you think it would be wise to sell out now, use some of the cash for living expenses, and hold the rest in cash with an eye to putting it back into the market at a better time –– say when stocks suffer a loss?
This is a good question and requires a two-part answer, one a warning, the other a strategy particular to this man’s needs:
- As readers of this blog should know well, I discourage efforts to “time the market.” No one can know how far the current rally will go. Selling out now could leave all your assets in cash accounts that uniformly pay rates of interest that are lower than the current rate of inflation, which means that the real value of your assets is eroding over time. A complete sale of your assets would mean that you could also miss out on any extension of this rally, as well as the natural tendency for stock prices to rise over time. Even if your presumed sale were now perfectly timed, and the market were to drop in the next few weeks or months, you still would have difficulty timing your return to the market. The market makes many false moves, and it could easily turn up, tempting you to buy in again, only to decline yet again. Thus a complete sale would be a bet against well-established long-term trends and you would also need to depend on remarkable luck –– and that’s not a good combination.
- But because you need some of this money in the near term, the present situation offers you a trading strategy that avoids the pitfalls of market timing. To take advantage of past price gains, sell enough to raise the funds you will need for the next two to three years while leaving the rest invested.
This trading strategy recognizes two fundamental aspects of investing. First, it considers the usual amount of time it takes for the market to recover from a significant bear move. Presumably, you have no need for the funds that you leave invested. Should the market suffer a downdraft, the two or three years you will leave the funds invested will be adequate time for the market’s inevitable recovery to make you whole –– and the likely extension of its gains. True, you would do better if your sale happened to be perfectly timed and you knew exactly when to buy back into the market, but that is impossible to know beforehand. Second, this trading strategy protects you from having to sell at lower prices should the market retreat in the near future. Effectively, this strategy accommodates the rule that anyone who will need funds in three years or less should not invest those monies in stocks.