Macro: Sandcastle economics
Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.
Summary: From time to time in your investing journey, you might want to reduce your risk. The simplest way to reduce your market risk is by being less invested in the market. You can achieve this by selling some or all your positions aka cashing out. While it might make sense to reduce your exposure by selling positions, there are important considerations you need to be aware of before you make the move.
When you buy stocks, bonds or any other financial instrument, you expose yourself to market risk. You probably do this to earn a positive return and make money. Imagine you have EUR 10,000. If you choose to invest the full amount, this is known as being fully invested (all your capital is on the table). You have created maximum exposure. High rewards are possible but there is also significant risk.
You could also choose to only invest a portion of the 10,000 or not invest anything at all. With the former, you are partially invested and with the latter, you are not invested at all. When you aren’t invested, you have no market risk but also no potential to gain when markets go up.
Over time, markets tend to go up. But there might be times when you feel uncomfortable with how the markets are moving or you think that the valuations are too high given the economic outlook. In such cases, you might choose to reduce your exposure by selling all or parts of your portfolio and have more cash at hand. The benefits of that move include:
Put another way: the stronger you believe markets will go up, the more you tend to be invested. Following that line of thinking you should decrease your exposure if your conviction declines.
There are many ways to reduce exposure. You can reduce exposure in increments or be more drastic and sell it all at once. You can choose to act immediately or act only as a result of a defined event using conditional orders.
As you can see, there are several ways to reduce your market risk – going all cash isn’t the only opportunity. The method you choose depends entirely on your view of the markets. If you are completely convinced that everything will fall, you might opt to sell everything. But if you are not so sure that we are on the edge of very strong market decline, other approaches might suit you better.
So now that you have cash in your account, that leaves the question of what to do with it. Of course, you can just leave it there. Then you will have no market exposure and you can start investing again when you are comfortable re-entering the market. But be aware that inflation is eating away the purchasing power of your cash!
Another possibility is to invest your cash in a money market fund that provides (some) return on your investment, although these can also have negative returns depending on the financial outlook and the currency it is denoted in.
Selling positions and going cash is a simple way to reduce your market risk. There are several ways to reduce market risk and the most radical one is to sell everything immediately. Other less drastic options exist depending on your viewpoint of the current market environment. Once you have a (maybe even 100%) cash position, it is clever to weigh the possibilities that exist to put that cash position to work in the lowest risk environment possible via e.g., a money market fund.