Nick’s Note: With stocks at all-time highs, many investors are going all-in. But keeping all of your money in stocks could result in underperforming the market.
So if you want to beat the market and build a sizable nest egg, you should hold cash during times like this. And today, longtime PBRG friend and master trader Jeff Clark explains the reason for it…
By Jeff Clark, editor, Market Minute
“You must be fully invested during market rallies,” a concerned reader wrote to me recently. “If you’re holding cash, you’re going to underperform the market.”
The reader is making a point that’s often preached by the majority of stockbrokers, money managers, and mutual fund salespeople.
“Don’t try to time the market,” they say. “Stay 100% invested, and you’ll keep up with the market’s returns over time.”
But the truth is—because of the various fees charged by those same stockbrokers, money managers, and mutual funds—if you stay 100% invested all the time, you’ll consistently underperform the market.
The only way to beat the market is to have cash available to buy stocks during the inevitable declines. And the only way to have that cash available is to slowly sell off positions as the market stretches into overbought territory…
Taking Money Off the Table
Let me try to explain how this works. Take a look at this chart of the S&P 500:
The S&P 500 first crossed above 2,800 back on January 17, 2018. That’s about 15 months ago. But recently, the index closed at 2,939. So if you were 100% invested for that entire time, you would’ve made just under 5% on your money.
But if you routinely took some money off the table when conditions got overheated, then you would’ve avoided some of the large downdrafts in the market. And you would’ve had cash available to put to work when conditions got oversold.
Technical indicators like the Volatility Index (VIX), the McClellan Oscillators (NYMO and NAMO), the CBOE Put/Call ratio (CPC), and others were warning of overbought conditions. So it seemed prudent to raise a little cash.
Of course, we ran the risk of underperforming the market if stocks continued to rally—which they did following our exit in January last year and have done since early February this year.
But when the market fell, as it did last February and last December, we had money available to put to work when the technical conditions reached oversold levels.
The technical indicators had reached extremely oversold levels. And while we didn’t nail the exact bottom of the market decline, we were able to buy stocks at far cheaper prices than where we had sold them previously.
Selling even just a small portion of your portfolio into overbought conditions—then buying back in when things get oversold—can have a very positive effect on your overall returns.
You Must Have Cash
Over the past few months, I’ve been advising folks to raise cash. Many technical indicators are in overbought territory and are flashing warning signs.
Yet the market has continued higher. So if you followed my advice for the past few months, then you’re underperforming the broad stock market.
I suspect that’s just a temporary condition. We’ll get a decent decline—sooner or later—that’ll give you the chance to buy stocks at lower prices than where they’re trading today.
But in order to buy when that happens, you’ll have to have cash.
Editor, Market Minute
P.S. As you can see above, my trading strategy is all about taking profits off the table and reducing risk.
And if you like what you just read, consider signing up for my free e-letter, Market Minute. You’ll receive more trading advice just like this—three days a week. You can sign up with one click right here.
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