Market Prospects Darken

Stocks have lost a lot of ground of late.  In the last month, the most used stock index, the S&P 500, has dropped over 10 percent.  Volatility from one day to the next is sufficient to unnerve even the most cold-blooded investor.  What may be still more upsetting, the Federal Reserve (Fed) has promised to constrain credit and lift interest rates higher than it already has.  Such policies, added to the ravages of inflation, make recession look likely in perhaps 12 to 18 months if not sooner.  So it’s only reasonable to wonder if investors should sell out.

My response is in two parts, depending – as it always does with investing – on the investor’s circumstances, time horizon, and objectives:

1. If you will need the money in the next year or so, then yes, sell out at least as much as you expect to need.  In the coming months, stock prices are more likely to fall than rise.  Take what you need now before you must accept lower prices and set the money aside in a safe place – preferably in a bank deposit – until you need it.
2. If you won’t need the funds that you presently have in stocks for 3 to 5 years or more, you may as well leave it where it is.  You will take a “paper loss” as stock prices fall, but over this time horizon stocks will almost surely more than make up for those losses and likely carry higher prices than they do today.  

Of  course, a perfect solution would be to get out now, hold the funds aside while stock prices fall and then jump back in at lower prices just as the next market upswing begins.  But few of us can arrange such perfect timing: you might reenter the market too soon and suffer disappointing losses before you see any gains; or, more likely, you will worry about moving back in too soon and thus fail to buy back in before the recovery has shown so much momentum that you buy in at today’s prices or higher – and have to pay transaction costs (and likely capital gains taxes) into the bargain.  So if you have no need for the money, it might as well stay where it is.  That way there will be less opportunity for error.