Should You Cash Out Of Stock Mutual Funds In A Market Downturn? (2024)

The stock market struggles to rally beneath the weight of hammer blows from inflation, Federal Reserve interest-rate increases, fears of a U.S. pandemic relapse and war in Ukraine. Amid all of that, mutual fund shareholders wonder how to avoid becoming collateral damage. Is cashing out of stocks and stock funds a smart way to protect their investments? Or should shareholders stay the course, stay fully invested?

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The answer depends on which segment of your portfolio you're asking about. There's one answer for the segment of your portfolio that you rely on for money to pay current and near-term retirement expenses. Call that the spending bucket portion of your portfolio.

For that retirement spending bucket portion, park your money in either cash or short-duration bond funds, whose value changes much less than stock mutual funds do amid market volatility.

We talk about how to do that in another IBD report.

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Cashing Out Of Stock Mutual Funds In A Rocky Market: Smart Or Not?

There's another, totally different answer for the segment of your portfolio whose job it is to keep growing faster than inflation. Call that the long-term growth portion of your portfolio.

That's your entire portfolio if you're young and more than about twoyears away from retirement. If you're within two years of retirement or already retired, it's likely still the bulk of your portfolio.

And that's what this report is all about: how to handle the long-term growth segment of your portfolio during a market crunch like the current pullback.

Bargain Bin

In fact, for the long-term growth segment of your portfolio, a market sell-off can provide a special bargain-buying opportunity that you'll benefit from in the long run — if your stomach can handle the volatility in the short run, and if you can afford to trim your take-home pay temporarily.

More about this special opportunity later in this report, after we explain who should stay the course with stock mutual funds rather than cashing out.

Cashing Out: Classic Choice

The Dow Jones Industrial Average officially dropped to severe correction status on March 7, although it returned to "Confirmed Uptrend" status with the overall market's follow-through day on Wednesday, March 16, as reported in IBD's The Big Pic column.

Mutual fund shareholders faced a classic strategic choice earlier this month. When the market melts, are you better off cashing out of stock fund shares and seeking safe havens in cash and bonds? Or is it better to stay in your stock funds and wait for the market to rebound?

Just remember, with your individual stocks, you buy, hold, add or sell based on the rules of atime-tested strategythat tells you when to get in and out of securities.

Are you a newcomer to investing who wants to buff up your stock investing skills? Check out this guide forstock market beginners.

Stay The Course With Long-Term Funds

With your mutual funds devoted to long-term growth, experts advise:stay the course.

You may ask, Why leave money in mutual funds that lose value in a downturn?

The answer is that individual mutual fund shareholders rarely, if ever, get out of the market near its top. And they rarely, if ever, get back into the market at its bottom.

For instance, inthe 10 years ended Dec. 31, 2015, the broad stock market in the form of the S&P 500 rose 7.31% on average each year. But by flitting into and out of the market in reaction to market ups and downs, the typical shareholder in U.S. stock mutual funds gained just 4.23% each year on average, according to research firm Dalbar.

It's like expecting to win a road race despite dropping out. It's tough to do.

Sell Low, Buy High?

Instead, time and again shareholders end up selling low— then buying high after missing the often explosive start to a rally.

Mutual fund investors tend to wait too long to get out, because it's human nature to try to avoid locking in losses, one J.P. Morgan Asset Management global market strategist told IBD.

Likewise, investors wait too long to get back in after exiting. Even after a rally starts, investors who cashed out keep waiting for the market to prove itself. "Periods of intense volatility will more often than not result in an investor missing the rebound days," said Jack Manley, J.P. Morgan Asset Management global market strategist.

In contrast, if you simply stay put, stay invested, you benefit from the market's remarkable history.

After all, the markethas recovered from every downturn.

And that includes the Great Depression, World War II and the Financial Crisis of 2008-2009.

Market Rallies Start Unexpectedly

Look what happened if you had invested $10,000 in the S&P 500 between the start of the year 2002 and last Dec. 31. If you stayed put, remaining fully invested through the market's ups and downs during those 20 years, your average annual return was 9.52%. Your nest egg would have ballooned into $61,685.

But if you got cold feet, cashing out when the market got rocky, what happened? If you didn't get back in soon enough to benefit from rallies after various pullbacks, and you missed just the 10 best market days during that 20-year period, your average yearly return got slashed by nearly half to just 5.33%, J.P. Morgan Asset Management calculates. Your end balance would have been a far more modest $28,260.

The more best days that you miss, the worse your portfolio's investment returns would have been.

If you missed just the 20 best market days, your annual rate of return would have shrunk to 2.63%. Your $10,000 would have grown to only $16,804.

If you missed the 30 best days, your return would have been barely positive, just 0.43%. Your $10,000 would have inched up to $10,904.

Are any of those outcomes really "protecting" your money?

Missing The Best Days Is Easy

And it's all too easy to miss the best days after cashing out. Seven of the 10 best market days occurred within two weeks of the 10 worst days from 2002 to 2021.

But mutual fund shareholders tend to still be on the sidelines when rallies make their explosive starts. "Big amounts of institutional money lead to quick snapbacks," a J.P. Morgan strategist once told IBD. "But individual shareholders tend to still be out of the market."

Hiding on the sidelines feels safe. It ends up being costly.

The Opposite Of Cashing Out

Staying fully invested — the opposite of cashing out — in the long-term growth portion of your mutual funds portfolio not only enables you to avoid missing out on big market rally days. It also provides you with a big positive benefit.

During a sell-off, you are buying shares in funds you've already decided you like for the long run at lower share prices. That means you're buying more shares, if you keep investing the same dollar amounts — and that's what you'd do unless you went out of your way to cut the size of your contributions.

Once a rally starts, those extra shares magnify your gains because you own more shares than you would have if the market had not pulled back. That benefit is known as dollar-cost averaging.

That is the special opportunity we referred to early in this report.

In fact, you can boost the benefit of dollar-cost averaging even more if you increase the dollar amount of your 401(k) contributions. If you can afford to do it and your risk tolerance will allow it, it's definitely worth considering, experts say. Just remember, the market could go down even more or stay down a long time.

A version of this story was first published March 7, 2020.

Follow Paul Katzeff on Twitterat@IBD_PKatzefffor tips about personal finance and strategies of the best mutual funds.

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