Get out. That's tempting investing advice with the stock market in a downward spiral. The idea is that simply getting out of the stock market altogether is the safest strategy right now.
However, reality is more complicated. Thinking about selling all your stocks? Here are two big risks you'll face.
Image source: Getty Images.
Missing out
Some investors have an exit strategy. They sell stocks during a correction to avoid taking an even bigger loss if a full-blown bear market occurs. There's a significant risk, though, that the lack of an effective reentrance strategy will ultimately cost more than staying in the market.
As a case in point, I personally know someone who sold all of his stocks back in late 2008. He did so before the bottom completely fell out. This appeared to be a prudent move -- for a while.
The problem, however, was that he was still too apprehensive about the market to again buy stocks in 2009. Even as the rebound picked up momentum in 2010, he continued to hesitate. Sure, he eventually did jump back in. However, he waited so long to do so that he would have been better off never selling in the first place.
You might think, "That won't happen to me. I'll only stay out of the market until the dust clears." But how will 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 rapid rebound in 2020.
Also, what will you do if you return to investing only for the market to plunge again? It's easy for such "whipsaws" to result in much greater losses than you'd incur by sticking things out.
Warren Buffett's "swindler"
There's also another key risk with selling all your stocks -- inflation. Your money will have 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 summarized the problem well in his comments at Berkshire Hathaway's (BRK.A 1.22%) (BRK.B 1.15%) recent shareholder meeting. The legendary investors said, "Inflation swindles the bond investor, too. It swindles the person who keeps their cash under their mattress. It swindles almost everybody."
As is often the case, Buffett was exactly right. You might think that you're avoiding losing money by exiting the stock market. However, with inflation at 40-year highs, the value of those dollars parked in bonds, savings accounts, or nearly every other place will still decline.
Sure, inflation can hurt stocks as well. Many businesses, though, hold 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, such as oil and gas companies right now, benefit because the higher prices contributing to rising inflation are tailwinds rather than headwinds.
Three magic words
I won't state that exiting the stock market altogether will definitely cause you to lose more than holding steady. Maybe you'll be able to time the market really well. However, I do think that most investors are better off remaining invested.
There are three magic words that might seem cliched but are nonetheless excellent advice: Think long term. Great investors such as Buffett have achieved their success by adhering to those three words.
Buffett hasn't sold all of the stocks owned by Berkshire during the recent market downturn. On the contrary, he's investing more heavily than he's done over the past couple of years. The "Oracle of Omaha" knows that corrections and bear markets can be a blessing for long-term investors.
