Cash Trades

Over the last few days several people have questioned, and a few even challenged me on the relatively large cash position I have been holding for most of this month. As I write this the S&P500 is down 3.8% for the year, the Small Cap Russell2000 index is off by 6.2%, the S&P500 is down nearly 6.2%, while the Nasdaq is down over 15%. At the worst levels the S&P500 had shed 15.5% for the year, the Nasdsaq 19.8% and the Russell2000 just over 16%. Since most Mutual Funds and Hedge Funds actually put in worse performance than the Indexes its likely that the majority of them are down more. With all this pain present in the market positive numbers are hard to come by, and those who are lucky enough to have competent individuals handling their money (be it themselves or a paid profession) are happy indeed. My own accounts, both managed and personal are up just under 5% for the year, so while many on message boards complain, I've not had a single client express anything but pleasure in the performance so for this year.
Having spent a large part of my childhood in what could be seen as extreme poverty I'm very aware of the value of money. The effect of this is that I've always been much more focused on the worst case scenario than on the best. This has protected both myself and my managed clients on a number of occasions, including this year so far. The biggest danger that an investor faces is that of large losses, either generated by reckless trading or a bear market. In either case the effect can be devastating and very hard to recover from. A loss of 20% requires a gain of 25% just to get back to your starting point, while a 50% drawdown would require stunning performance to generate the 100% gain needed to get back to even. These are numbers you should BURN into your brain and always be considered. Note also that the losses generated from a bear market can take a heck of a long time to recover from, especially when you consider the inflation adjusted returns. The losses of the Nasdaq in this decade provide an excellent example of the damage a bear market can inflict upon investors. The Nasdaq 100 is up over 120% from its 2002 lows, but in spite of this spectacular gain it is still down nearly 64% from its 2000 highs. Long term investors in the Nasdaq will not find themselves BREAKING EVEN from 2000 levels until the market rallies yet another 175%. This is in real, not inflation adjusted terms. It's likely going to be several years until the Nasdaq finds itself back above water, and several more before it does so in real terms. Investors who bought DOW stocks in the mid 60's found themselves waiting nearly THIRTY YEARS, until the early 1990's to recover from the hit they took in a brutal bear market. Can you wait 30 years on your investments JUST TO BREAK EVEN? Even if you can, do you want to?
So what is the solution to this rather scary situation? In my mind trading into cash during periods of extreme uncertainty and declines. I charge no management fee's which means I only get paid for positive performance, doing better on a relative basis does me no good at all if the result is still a loss. So, even though being cautious might cost me a few percentage points on my overall performance, causing me to be paid less, its better in my mind than the alternative. Yes, maybe my gains, and as a result my paycheck, will be smaller for a short period of time. But, compared to suffering large, unrecoverable gains I'm a happy camper, and so are the clients put their own hard earned money in my hands to manage.