Stock Investing – Don’t Be Rhinophobic

Rhinophobia is an investor’s disease: the dread of having any cash. The rhinophobic feels that all of his or her ”stock money” must be fully invested at all times.

Let’s say you are an individual investor and have settled on an asset allocation of 60{3d5275f9508c9dd4021075398e098e5db9cf49de07ee931b769af6a77a0ab5ee} stocks, 40{3d5275f9508c9dd4021075398e098e5db9cf49de07ee931b769af6a77a0ab5ee} bonds. So if your total investable money is $100,000, then $60,000 is your ”stock money.”

Question: Should all of your stock money always be invested in stocks? If you answer ”Yes,” you have rhinophobia and should see a doctor. Or just read the rest of this article. Because the better answer-more likely to keep you financially healthy-is ”No.”

It is an unfortunate myth in the stock-investment industry-including many pundits and mutual funds-that the smartest investors are fully invested at all times. In other words, they invest cash as soon as they get their hands on it, ”never sell,” and if they do sell, they reinvest the proceeds immediately. This myth is obviously a corollary of a dogmatic Buy-and-Hold ideology.

The reason that the myth is unfortunate is that it causes people to lose money. It is the reason why so many investors who were fully invested when the market peaked in early 2000 stayed fully invested as the market went all the down over the next three years, rather than getting out until the crash stopped. It’s also why many of them will stay fully invested the next time a bubble pops or a bear market claws them up.

Even those perceived to be the most conservative stock investors-”value” investors with a Buy-and-Hold bent-in fact time their moves to avoid rhinophobia. They do it when they decide not to purchase a stock because it does not meet their valuation criteria (”We’re waiting for a better price”), or to sell a stock because it has met their target price (”We think this stock has had its run-we are very disciplined about selling when a stock hits our target price”). They are actually practicing a form of (cover your kids’ eyes here) timing.

If you ask the average informed investor what Warren Buffett’s investing style is, he or she is likely to say, ”Buffett is a value investor with a Buy-and-Hold approach.” And that would be generally accurate. But Buffett avoids rhinophobia. Here’s what he said in his 2003 annual letter to Berkshire Hathaway shareholders: ”Sitting it out is no fun. But occasionally, successful investing requires inactivity.” As recently as May, 2006, Forbes magazine reported that ”Buffett, to the vexation of investors, is sitting on a mountain of cash and bonds (50{3d5275f9508c9dd4021075398e098e5db9cf49de07ee931b769af6a77a0ab5ee} of Berkshire’s market value) waiting for better opportunities.”

Why would that vex Berkshire Hathaway shareholders? Buffett obviously knows what he’s doing, judging by his record over the past five decades. He is, after all, the world’s richest person whose wealth came entirely from investing. What any ”vexed” shareholders are forgetting, and he is not, is that Rule #1 in stock investing is, ”Don’t lose money.” Sometimes, not losing money requires the Sensible Stock Investor to have his or her ”stock money” in cash, not in stocks.

If, for whatever reason, you sell a stock, there may be times when you do not want to reinvest the money right away. Rather, you may want to hold it in cash for a while, until conditions change for the better. Same thing if you come into possession of new money. Don’t be afraid to be uninvested. If you cannot find enough good places for your ”stock money,” let it sit in cash until valuations improve, market conditions change, or you discover a promising new investment opportunity.

In other words, your strategy as a Sensible Stock Investor should include a strategy for cash. To manage a stock portfolio sensibly, cash is a legitimate parking place for ”stock money” when:

o You’re in a generally declining or sideways market-nothing seems to be doing well.

o You’re in a deflating bubble, like the 2000-2002 deflation of the 1990s bubble.

o No great stock investment opportunities are apparent.

o You are in a protection mode.

When you are an individual investor, it is like running your own little business or mutual fund. You want to run it intelligently. Now, the excellent companies that you invest in do not ignore timing in running their own businesses. They do not mindlessly charge ahead with relentless product introductions, marketing campaigns, and acquisitions, regardless of the economy, interest rates, and their own industry’s conditions. Sometimes, they hang onto their investable cash (retained earnings) awaiting good opportunities. They study their markets, identify trends and changes in their industry, and adjust their actions through a continual process of strategic evaluation. They manage risks this way.

Don’t expect anything less of yourself as an investor. Why would you passively hang on to all your stocks during an extended period of obvious market decline, such as 2000-2002? It does not make sense. It is rhinophobia, a disease that will make you poorer.

Don’t be rhinophobic. Your investment performance will be much better if you inoculate yourself against this disease. Do that by exercising caution. Be willing to invest new cash when you identify a promising opportunity, but do not feel a need to be fully invested all the time. Cash is fine whenever good opportunities are not apparent.