Go out. This is tempting investment advice with the stock market in a downward spiral. The idea is that the safest strategy right now is to just exit the stock market altogether.
However, the reality is more complicated. Are you considering selling all of your stocks? Here are two big risks you face.
Some investors have an exit strategy. They sell stocks during a correction to avoid an even bigger loss when a full-blown bear market hits. However, there is a significant risk that not having an effective re-entry strategy will ultimately cost you more than staying in the market.
As a case in point, I personally know someone who sold all of his shares at the end of 2008. He did so before the bottom fell out completely. This seemed like a smart move – for a while.
The problem, however, was that he was still too worried about the market to buy shares again in 2009. Even as the recovery gathered momentum in 2010, he continued to hesitate. Sure, he eventually jumped back in. However, he waited so long that he would have been better off not selling in the first place.
You might think, “This isn’t going to happen to me. I’ll just stay out of the market until the dust settles.” But how do you know when is the best time to invest again? The stock market is unpredictable. It can sometimes recover so quickly that even well-intentioned investors miss out on gains. Just look at the steep sell-off and quick recovery in 2020.
And what will you do if you invest again only to see the market crash again? It’s easy for such “pulling saws” to result in much larger losses than sticking things out.
Warren Buffett’s “cheaters”
There’s also another major risk in selling all your stocks — inflation. Your money has to be parked somewhere if you sell all your stocks. But there are few alternatives that are safe from the effects of inflation.
Warren Buffett summed up the problem well in his comments Berkshire Hathaway‘s (BRK.A 0.73%) (BRK. B 0.75%) last shareholders meeting. The legendary investors said: “Inflation cheats the bond investor too. She cheats on the person who keeps her money under the mattress. She cheats almost everyone.”
As so often, Buffett was spot on. You may think that you avoid losing money by getting out of the stock market. However, with inflation at 40-year highs, the value of those dollars parked in bonds, savings accounts, or just about anywhere will still fall.
Of course, inflation can also hurt stocks. However, many companies are holding up quite well during periods of high inflation. Some have escalators in their contracts with customers that automatically increase prices based on the consumer price index. Others, like oil and gas companies at the moment, are benefiting because higher prices, which are contributing to rising inflation, are tailwinds rather than headwinds.
Three magic words
I’m not going to argue that exiting the stock market entirely will definitely cause you to lose more than staying steady. Maybe you can time the market really well. However, I think most investors are better off staying invested.
There are three magic words that may seem cliche, but are still good advice: Think long-term. Great investors like Buffett have achieved their success by sticking to those three words.
Buffett didn’t sell all of Berkshire’s stock during the recent market downturn. On the contrary, he is investing more than in recent years. The “Oracle of Omaha” knows that corrections and bear markets can be a boon for long-term investors.