When markets are volatile and you start to see your portfolio shrink, there may be an urge to withdraw your money and put it somewhere safe, but acting on that desire can expose you to a higher level of risk.
In fact, there is an entire field of research devoted to investor behavior and the financial consequences of following your emotions (hint: the results are less than ideal).
A better strategy might be to anticipate your own natural reactions when markets fall, or when there is a stock market crash, and wait to make investment decisions based on more rational thinking (or even a set of rules that has set to in advance).
after all, for many investors, especially younger investors, time in the market often beats time in the stock market. Here’s an overview of factors investors might consider when deciding whether to keep money in the stock market.
investing can be an emotional ride
An emotion-driven approach to the stock market, whether it be a flash sell or a stock buy, can stem from an attempt to predict short-term movements in the market. this approach is called timing the market.
And while the notion of trying to predict the perfect time to buy or sell is familiar, investors are also prone to specific behaviors or biases that can expose them to greater risk of loss.
surrender to fear
When markets experience a sharp decline, some investors may be tempted to give in to the fud (fear, uncertainty, doubt). investors may assume that by selling now they are protecting themselves against future losses.
However, this logic assumes that investing in a falling market means that the market will continue to fall, which, given the volatility of prices and the impossibility of knowing the future, may or may not be the case.
Focusing on temporary dips could force some investors to make rash decisions that they later regret. after all, over time, markets tend to correct themselves.
following the crowd
Similarly, when the market moves up, investors can sometimes fall victim to what’s known as fomo (fear of missing out): buying on the assumption that today’s growth is a sign of the continuous rise of tomorrow. That strategy doesn’t guarantee success either.
why time in the market matters
answering the question “should I take my money out of the stock market?” it will depend on an investor’s time horizon, or the amount of time they intend to hold an investment before selling it.
Many industry studies have shown that timing the market is often a smarter approach than trying to time the stock market or giving in to panic selling.
One of these groundbreaking studies by Brad Barber and Terence Odean was titled “Trading Is Dangerous to Your Wealth: Returns on Investing in Common Stocks for Individual Investors.”
published in April 2000 in the journal of finance and was one of the first studies to quantify the gap between market returns and investor returns.
• market returns are simply the average return of the market itself over a specified period of time.
• investor returns, however, are what the average investor tends to reap, and investor returns are significantly lower, the study found, especially among those who trade more often.
In other words, when investors try to time the market by selling when it goes down and buying when it goes up, they actually lose.
Conversely, keeping money in the market for a long period of time can help reduce the risk of short-term declines or declines in stock price. staying put despite periods of volatility, for some investors, could be a good strategy.
An investor’s time horizon can play a significant role in determining whether or not they want to exit the stock market. In general, the more time an investor has to get out of the market, the less he will want to worry about his portfolio during the turmoil.
Compare, for example, the scenario of a 25-year-old who has decades to recoup short-term losses versus someone who is nearing retirement and needs to start withdrawing money from their investment accounts.
is it ok to withdraw from the market during a recession?
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There is nothing wrong with deciding to withdraw from the markets if they go south. But if you sell stocks or other assets during a recession, you risk locking in your losses, as they say. depending on how much the values have decreased, you may lose some of your profits or you may lose some or all of your principal.
In a perfect world, if you do it at the right time, you could withdraw your money at the right time and avoid the worst, and then buy back, just in time to recover. while this sounds smart, it is very difficult to achieve.
benefits of withdrawing from the market
The advantage of withdrawing from the market and keeping your money in cash is that cash is not volatile. Generally speaking, your cash won’t lose value overnight, and that can give you some comfort both financially and psychologically.
as stated above, if you make your move at the right time, you can avoid steeper losses, but without a crystal ball, there are no guarantees. That said, through the use of stop-limit orders, you can create your own safety measures by automatically triggering a sale of certain securities if the price hits specific lows.
disadvantages of withdrawing from the market
There are some downsides to taking cash out of the market during a recession. First, as discussed above, there is a risk of locking in losses if you sell your holdings too quickly.
Potentially worse is the risk of losing the bounce as well. blocking losses and then losing profits basically acts as a double loss.
When you realize certain losses, like when you realize gains, you will likely have to deal with certain tax consequences.
And while moving to cash may feel safe, because you’re unlikely to see sudden declines in your cash holdings, the reality is that holding cash increases the risk of inflation.
💡 recommended: how to protect your money from inflation
use of limit orders to manage risk
A market order is simply a basic trade, when you buy or sell a stock at the market price. But when markets start to fall, a limit order does exactly that: it puts a limit on the price at which you’re willing to sell (or buy) securities.
Limit orders are automatically triggered when the security reaches a certain price. for sell limit orders, for example, the order will be filled at or above the price you set. (A buy limit order means the trade will only be executed at that price or less.)
By using certain order types, traders can potentially reduce their risk of losses and avoid unpredictable swings in the market.
alternatives to getting out of the bag
Here is an overview of some alternatives to exiting the stock market:
rotation to safe haven assets
investors could choose to rotate some of their investments into safe haven assets (ie those that are not correlated to market volatility). Gold, silver, and bonds are often considered some of the safe havens investors turn to first in times of uncertainty.
By rebalancing a portfolio so that fewer holdings are affected by market volatility, investors could reduce the risk of loss.
Re-evaluating where to allocate one’s assets is not an easy task and, if done too hastily, could lead to long-term losses. therefore, it may be helpful for investors to speak with a financial professional before making a big investment move driven by the news of the day.
have a diversified portfolio
Instead of shifting investments to safe-haven assets such as precious metals, some investors prefer to cultivate a well-diversified portfolio from the start.
In this case, there would be less need to rotate funds into “safer” investments during a downturn, as the portfolio would already offer enough diversification to help mitigate market volatility risks.
Reinvesting dividends can also allow a long-term investor’s portfolio to continue to grow at a steady rate, even when stock prices temporarily decline. Knowing where and when to reinvest earnings is another factor investors may want to consider when deciding which strategy to adopt.
(Any dividend-earning stock owned by an investor must be owned on or before the ex-dividend date. Otherwise, the dividend will not be credited to the investor’s account. Therefore, if an investor decides to exit the market share, they may lose the payment of dividends).
rebalance a portfolio
Sometimes astute investors also choose to rebalance their portfolio in a downturn by buying new stocks. it is difficult, although not impossible, to benefit from new trends that may emerge during a crisis.
It’s worth noting that this investment strategy doesn’t involve taking money out of the stock market, it just means selling some stocks to buy others.
For example, during the initial shock of the 2020 crisis, many stocks suffered sharp declines. but there were some that outperformed the market due to certain changes in the market. stocks of companies specializing in work-from-home software, such as those in the video conferencing industry, saw value gains.
Keep in mind, however, that these gains are often temporary. for example, home-training equipment such as exercise bikes were in high demand, driving related stocks higher. some telehealth companies saw share prices rise. but in some cases, these gains were short-lived.
Also, for newer investors or those with low risk tolerance, trying this strategy might not be a desirable option.
asset allocation reassessment
During recessions, it might be worthwhile for investors to examine their asset allocations, or the amount of money an investor has in each asset.
If an investor has stocks in industries that have struggled and may continue to struggle due to falling demand (think restaurants, retail, or oil in 2020), they may choose to sell some of the stock whose value is decreasing.
Even if such shares are sold at a loss, the investor could invest the money obtained from the sale of these shares in safe-haven assets, potentially recouping their recent losses.
having cash has its benefits
Cash can also be an additional asset. Naturally, the value of cash is determined by things like inflation, so its purchasing power can swing up and down. still, there are advantages to accumulating some cash. money invested in other assets, after all, is, by definition, tied to that asset. that money is not immediately liquid.
Cash, on the other hand, could be set aside in a savings account or emergency fund, free of the burden of a specific investment. Here are some potential benefits to cash holdings:
First, on a psychological level, an investor who knows they have cash on hand may be less likely to feel like they’re at risk of losing it all (when stocks fluctuate or wobble).
A side benefit of cash involves having some “dry powder,” or money on hand that could be used to buy additional shares if the market continues to fall. when investing, it can be beneficial for an “opposite”, who runs against the crowd. In other words, when others are selling (ie scared), a smart investor might want to buy.
Taking money out of the market during a recession is a natural impulse for many investors. after all, everyone wants to avoid losses. but trying to time the market (when there is no crystal ball) can be risky and stressful.
For many investors, especially younger ones with a longer time horizon, holding money in the stock market can pay off over time. One approach to investing is to set long-term investment goals and then strive to stay the course, even when facing market headwinds.
Always, when it comes to investing in the stock market, there is no guarantee of increasing returns. therefore, individual investors will want to examine their personal financial needs and short-term and future financial goals before deciding when and how to invest.
While managing money during a market downturn may seem complicated, getting started with investing doesn’t have to be. It’s easy, convenient and safe to set up an investment account with Sofi Invest.
sofi invest® is a secure application where users can take care of all their investment needs, including stock trading, buying and selling cryptocurrencies, investing in opi stocks and more. It also provides SOFI members with access to free financial advice and actionable market insights. Ready to start investing?
frequently asked questions
should you withdraw from the stock market?
Ideally, you don’t want to impulsively take your money out of the market when there’s a crisis or sudden volatility. While a falling market can be disconcerting and the desire to invest your money in safe investments is understandable, it can actually expose you to more risk.
when is it smart to get out of stocks?
In some cases, it may be wise to withdraw your money from certain stocks when they reach a predetermined price (you can use a limit order to put those safety measures in place); when you want to buy new opportunities; or add diversification to your portfolio.
what are your options to exit the stock market?
There are always options besides the stock market. Which ones are more attractive depends on your goals. you can invest in safe investments (for example, bonds or precious metals), you can put your money in cash; you can consider other assets such as real estate.
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