I came across the following chart in a recent article, “The Fateful Message of Cash” by Nick Murray.

Essentially there is one dollar in a money market fund for every two dollars of  equity common stock in the marketplace. As you can see from the chart, 10 cents for every dollar is a more reasoned expectation.

This strikes me as extreme fear in the market and while fear can be the emotion of choice for a while, it will pass.  When it does, there will be an “immense river of cash building up behind an earthen dam of fear. The cash is a force of nature; the fear is a human emotion. The cash must move-it cannot remain where it is, earning no return- while the emotion, like all nearly unanimous emotions, must eventually give way.”

Nick goes on to write that “This is not a call on the market. It is a cry from the heart: eschew unanimity. The mob is never right, other than momentarily. And history may yet show that it was never more wrong than in the days when it was holding a dollar in cash for every two dollars of common stock in America.”

I agree with his sentiments.

With cash serving as the latest investment fad in what is looking like a fright to quality, who would have thought that the mattress industry would be suffering? Simmons Bedding Co., the country’s second largest mattress maker has hired bankruptcy lawyers as it looks for new backers. In this environment, the strategy of keeping your money under mattresses would require the purchases of many more mattresses. Unfortunately for Simmons, this mattress stuffing strategy isn’t as attractive as money market funds-although both alternatives are basically providing the same return.

With the current spate of scary news combined with rapidly declining portfolio values many investors contemplate getting out of equities in advance of further anticipated losses. An investors risk preferences can change, but a change to the portfolio should only be considered once there is a clear understanding of the trade-offs and corresponding risks of such an action.

A comprehensive wealth management solution addresses the multiple risks spanning the entire planning horizon and determining the trade-offs associated with reducing or eliminating some risks at the expense of increasing or taking others. These include:

1) Market risk - the risk that stock prices will decline.

2) Inflation risk - the risk of losing long-term purchasing power.

3) Longevity risk - the risk of outliving your money.

Getting out of equities conveys a desire to eliminate market risk, or the chance of further declines in the value of the portfolio. However, this action will magnify the risk of losing purchasing power, as a market-risk-free investment is almost guaranteed to lose money after tax and inflation. This loss of purchasing power could increase the chances that a client will outlive his money, especially if he maintains a high level of spending relative to assets.

Sound advice is indispensable in this situation, as there is no “right” set of trade-offs. For example, an older investor with substantial assets relative to spending might never outlive his money, even if he invests in cash equivalents and accepts more inflation risk. His trade-off may be to give up the potential for philanthropy and/or the upside of a substantial estate for heirs in exchange for lower market risk. This may be a perfectly rational decision.

Another investor with a longer time horizon and/or higher spending relative to assets may also choose to eliminate market risk. However, he may have to offset higher inflation and longevity risks by accepting other trade-offs, such as working longer and/or significantly reducing long-term lifestyle expectations. Once again, this could be a rational choice.

In contrast, it is more likely for individuals expressing a desire to get out of equities to regard their potential action as a temporary move to the sidelines rather than as a long-term or permanent decision. Their proposed strategy may be to ride out the storm until the weather improves.

There are obvious problems with this attempt to time the market. Once a client decides to get out, the next question is when to get back in. He may feel it is more prudent to wait for stabilization or strengthening of the economy as a sign the market will recover. However, a recovery in the equity market will tend to lead a recovery in the economy. In this example, by the time the weather appears clear from the harbor, the tide may have already gone out.

When we ignore taxes and transaction costs, buying stocks and continuing to hold them are basically the same decision, and one should view the function of their allocation on a forward basis to assure that their portfolio is properly position to provide for future and or continuing outlays.

Although the mattress approach to investing may be a rational choice for some investors willing to trade market risk for other risks. The table below shows the approximate number of years to recoup a 45% decline assuming various rates of expected return.

No one can predict the future-and stock prices may decline further before they recover-but if long-term investors want to flee the market, it will be likely that they will not reach their previous highs within the next 30 years!

The decline in stock prices has certainly been dramatic and painful. The following considerations can better frame for you the ongoing decision making process:

1) Risk is multi-dimensional: Eliminating one risk may magnify another.

2) Stock prices and the business cycle: A recovery in stock prices tends to lead a recovery in economic conditions, and there is no evidence that risk premiums become reliably negative during recessions.

3) Stock returns and economic conditions: Market returns tend to be countercyclical (i.e., lower when economic conditions are strong and higher when they are weak).

4) Prices reflect all current information: More bad news will not necessarily cause further stock price declines; it is news relative to expectations that matters.

5) Payback time: Weigh the upside of higher expected returns against the probability that equity markets will not reach previous highs within the payback period associated with a market-risk-free investment.