Should I Be Fully Vested Or Hold Cash?

Warning: I am not giving you any stock recommendations. You should consult a professional for any investment advice.

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A reader, Jacob, wrote in with a question that mystified many investors.

“Hey Kelvin, I’ve been struggling with this issue for the past few years. I can’t decide how much cash or stocks should I hold. I thought I was right by switching into 50% cash since 2016 but it seemed like my cash could’ve deployed into stocks like Shopify. Their MRR and GMV grew very well. What do you think?”

His question inspired me to come up with an excel to share with you exactly how investors get it wrong when they try to time the market.

Before that, I have a few assumptions in my excel:

• The investor is competent.
• All scenarios start with $10,000 as starting capital.
• On a normal year, the returns are set at compounding 20% per year.
• Every 10 years, there is a crisis where the entire stock portfolio will drop by 40%.
• A year after crisis, the entire stock portfolio goes back by 80% if you’re remain fully vested throughout the 10 years period.
• However, if you went cash 2 years before crisis (scenario 2), the entire stock portfolio goes back by 60% only.

What is the underlying reason?

You can’t eat your cake and have it.

If you choose to time the market, you would never capture the bottom. You would have bought at somewhere before the market bottoms and recovers fully. You can’t capture the entire upswing.

But if you’re fully vested all the way, you will also enjoy all the wealth destruction during a crisis and all the wealth creation after a crisis.

Scenario 1

In the period of 29 years, due to two crisis (year 10 and year 20), the CAGR dropped from 20% to 17.6%.

Scenario 2A

In this beautiful scenario where an investor is able to time the market 2 years before the crisis, he would achieve 19.4% CAGR returns. That’s 1.8% returns more or $583,231.27 more over the period of 29 years.

But is life so accurate all of the time?

Among my friends, I do know of people who have been holding cash for more than 3 years.

Scenario 2B

How about timing the market and going cash 3 years before a crisis happens?

You’ll make 17.9% CAGR. That’s 0.3% more than scenario 1. My conclusion is… while one can do market timing, it involves far more effort to squeeze out an extra 0.3% returns.

Instead of focusing time and energy on timing the market or economy, why not, stay fully vested in high-quality growth companies and let market decide for itself?

Here’s the biggest revelation about myself… I never think too much whether the entire market (S&P 500) is overvalued or undervalued. It speaks nothing on whether the business I’m buying is overvalued or undervalued.

I’m buying the businesses, not the market. Why should I care?

Would I, because I thought the market was overvalued, not buy a superb company that’s trading at reasonable valuations? That would not be very wise.

You can give it a go at timing the market, but many have failed. Many were shouting for a stock market crisis since 2016. That was 3 years ago!

When it happens, it happens. Anyway, during crisis, the stock price may drop but the businesses could be still growing and they might buy back their shares!

Scenario 3

What if I am an investor who is 70% vested and 30% in cash?

Out of the initial capital of $10,000, $7,000 goes to work and generates $1,400 returns (20% returns). Assume, during a crisis, the investor pours his 30% of cash into the stock market and the entire portfolio grows by 60% in the first year, 20% in the second year and 20% in the third year.

Your CAGR would fall to 13.9%. That’s very far from scenario 1 and scenario 2.

Is rotating in and out of cash a wise move? Sometimes, doing more may cause us to earn even lesser!

Scenario 4 

In a scenario where an individual deploy his initial cash during a crisis only, his CAGR would be 3.3% over the period of 29 years. This shows the importance of staying vested and investing in good quality companies.

Link to View the Spreadsheet

Go to https://drive.google.com/file/d/1VD_lfn3TGCo47Bsdj6GKFHJ_JMSTtwJN/view?usp=sharing.

Is 20% CAGR Impossible?

Look at companies like MSCI, Moody’s, Credit Acceptance, Hypebeast, Dream International, Facebook, Craneware, Games Workshop, Nanosonics, Appen, or Fair Isaac Corporation.

There are many more. Look at their share price and use this website to compound their CAGR returns.

Conclusion

If you’re a competent investor and you know what you’re doing, plus you’re buying your businesses at superb valuations, there is no reason why you should not deploy your cash and put it to work.

By timing the market, you may miss out on good companies.

You fear the market is going to crash.

You fear that Donald Trump is going to pull the market down.

You fear that China Manufacturing Index is not performing.

You fear that the oil prices are going down.

You fear this and fear that.

That’s not going to make you a good investor.

I asked a top microcap investor this question before, “do you ever fear the market?”

He replied, “I care whether the businesses in my portfolio is growing their sales and profits every year, whether the management is doing the right thing, whether the quality of business is still in tact. I have absolutely no clue where the market is tomorrow or next week. If you ask me this question 2 months later, my answer to you will still be the same.”

It’s so easy to sell your stocks because of some news. That’s the lazy way.

In my view, I deploy my cash not based on the market but based on attractiveness of the companies I’m analysing.

Remember, you’re not buying the market. You’re buying individual businesses.

Watch this!

I’m open to suggestions, email me at kelvesy@gmail.com for more interaction!