Don't Be in Stocks If You Need the Money Soon

By David J. Kupstas, FSA, EA, MSPA

David J. Kupstas, FSA, EA, MSPA

David J. Kupstas, FSA, EA, MSPA Chief Actuary

The stock market has taken a beating recently. Over the four business days from August 20-25, the Dow Jones Industrial Average fell by 354.63, 530.94, 588.40, and 204.91 points, respectively – a decline of 9.68% in all. Whether you are a personal or institutional investor, despite this stomach-churning volatility, the advice you will receive is probably the same: “It’s just a ‘correction.’ Hang tight. Stay the course.”

I can appreciate that. While 500-point drops in the Dow are disconcerting to see on TV or the internet, it is true that the major stock indices have indeed eventually gone back up over time. So the advice to stay in the market makes sense – in most cases. But what if there is not enough time to wait around for the market to “eventually,” maybe, go back up? What if you need the invested money in one month or six months, before the market can recover? The answer probably is, you shouldn’t have been in the market in the first place. Someone like that should be invested in cash or at least in a conservative fixed-income portfolio

This is why when one of our defined benefit pension clients announces it is ready to terminate its plan, among the first steps we suggest is, “Go to cash.” All the plan assets should be sold as soon as possible and replaced with something like a money market fund or other interest-bearing account that will not lose principal. You just can’t predict what the market will do over the short term. What if there’s another 9/11? What if there are days like we’ve just seen here in August 2015? Suddenly, a plan sponsor that could afford to terminate its plan may no longer be able to do so.

Here is a recent example. One of our clients which we’ll call the ABC Company has a small cash balance plan that it would like to terminate. On September 30, 2015, the plan will need to have $800,000 in order to pay the benefits owed to participants. As of today, the plan has $795,000, so sometime in the next month it needs to write a check for $5,000 to fully fund the plan. For ABC Company, $5,000 is a very manageable amount to pay.

Things could have turned out very differently, though. You see, the value of plan assets was also $795,000 back on June 26, right after ABC made the decision to terminate its plan. That was the day on which ABC Company sold all of its plan assets and locked in the gains already earned. Being $5,000 short of its goal, ABC could have decided to stay invested and make up the shortfall through investment gains. Sometimes that strategy works. This time, it wouldn’t have. Had ABC Company not liquidated its plan assets, they would have had a value of $753,000 at the close of business August 25 -- $47,000 short of what will be needed at the end of next month. I would not have wanted to be the one to tell them their bill just went up by $42,000. Would you?

The moral of the story is, know your time horizon. While it may be tempting to try to squeeze the last dollar of investment return out before the end of the game, the last few days should be a reminder of how quickly things can veer off for the worse and that the market’s climb to new heights is not a straight path.

— Topics: Retirement, Market Performance, Financial Planning