Cash in spotlight amid sell-off

A market correction always tests the mettle of financial advisers and can offer opportunities for them to reinforce their value to clients.

In times of uncertainty, such as the markets have experienced over the last few weeks, many clients will reach out to advisers for reassurance and guidance. Advisers, however, should reach out to them.

Some clients will want to know if they should move some or all of their portfolios to cash. The answer for most will be: No. Stay the course. You are a long-term investor and your portfolio can handle the short-term volatility. In addition, market timing is very difficult. As difficult as it is to know when a correction is real and it’s time to move to cash, it is just as difficult, if not more so, to know when the bear market is over and it’s safe to move back into stocks.

Besides, advisers can point out, moving to cash now would most likely lock in what are at present only paper losses. Most clients are in mutual funds and would have to sell the shares in those funds to move to cash.

For those close to or in retirement, a move to increase cash holdings might have been prudent soon after the correction began. Now it’s a tougher question, and the answer depends on each client’s situation and risk tolerance.

Most mutual funds have some cash reserves to meet redemptions and to make strategic purchases, but generally do not move significantly to increase cash in market downturns.

However, some mutual funds have moved to cash, and clients might ask about them. They might challenge advisers: What do those mutual funds know that you don’t know? Should we be in them? Advisers must be prepared to give reasoned answers.

STRESSFUL TIMES

Advisers should know whether or not moving significantly to cash is a strategy these funds normally use, or if this time is different. What did they do in the past? If this time is different, why?

If they normally have moved to cash in stressful times, what signals did they use to know when to make such a move? When did they get back in, and what signals do they watch to tell them when?

What does their long-term record say about the success or failure of their market-timing efforts? How did those funds perform in 1987 when the market was down 22% in a matter of days, in 1990 when the market declined 18% between July and October, when the tech bubble burst in March 2000, in the March 2007 to June 2009 bear market? When did they get out and when did they get back in?

GOOD OR BAD

Clients might suggest putting money into those funds. Advisers must be able to weigh whether that makes sense for each client at this time. At the very least, they should point out that it likely would involve pulling money out of existing investments, and might be making the move too late.

Being able to discuss the mutual funds that use significant moves to cash to control risk in such depth will only add to the value advisers bring to their clients.

Cash can be good or bad — good when managers build it early in the correction, and then redeploy it soon after the recovery begins, bad when the managers are late to build cash and late to put it back into the market. Many managers are good at one decision — knowing when to get out — but not two in a row, which includes knowing when to get back in.