The money in cash myth
March 18, 2013
by Brian Wolf

Now that the stock market has had some recent gains, you would think that the people who live and die by the market would be very content. This, however, is rarely the case. It doesn’t seem to matter if the market is gaining or losing. there is always the worry of trying to second guess or predict the next direction for the market.

For some people, this is what gives them excitement and enjoyment, for most (especially retirees), this is what gives them sleepless nights. If there was one thing that I could leave as a legacy for all the people that I’ve meet in my financial planning career, it might be this; don’t believe everything you read, and certainly don’t believe everything that you read just because it supports what you want to believe.

Periodically, you will see articles like the one below on financial websites that discuss how “tons of money is sitting in cash.” They like to use that information to make you think that the market has a lot of room to grow. http://www.cnbc.com/id/100511878

There is only one problem with articles like this; they can be very misleading!

So, how might they mislead you?

Think about it this way. Let’s say that you have $1,000,000 sitting in cash because you are scared of which way the market may go. But then, for whatever reason, you decide you have changed your mind and are ready to invest that $1,000,000.

To keep this example simple, let’s say that you decide to buy $1,000,000 of Berkshire Hathaway (Warren Buffett’s company), so off you go and you buy the stock.

Your $1,000,000 is no longer on the sidelines. You are invested in the market. Isn’t this a bull market signal? Not so fast!

What did this transaction look like from the other side?

Someone had that $1,000,000 of Berkshire Hathaway. When they sold it to you, they gave up the stock and now they have (what was your $1,000,000) sitting in their cash account. In other words, you just participated in a zero-sum game.

You traded your cash position with another person who had a stock position. Before the transaction, there was one person with $1,000,000 of cash (you) and another person with $1,000,000 of stock (them). After the transaction there was one person with $1,000,000 of cash (them) and one person with $1,000,000 of stock (you). The net outcome: overall, nothing changed.

The moral of the story – you may want to ignore anyone telling you that “cash on the sidelines” is an indicator of which direction the market may go. Remember, there is no such thing as a can’t lose strategy when it comes to picking stocks and/or figuring out which way the market is going to go.

I personally like the strategies that allow my clients to make money when the market is going up, and then allows them to not lose money when the market is going down. If you want more information on this, you’ll have to see me in person, because as I pointed out earlier, you shouldn’t believe everything that you read!

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