Investing in stocks – better than holding cash?

While it is true that investing in equities yield better returns than holding cash, it does not mean that you will always do better investing than doing nothing.

When factoring in the realities of how people invest (not speaking about biases /flaws but simply how life works), the returns of stocks do not translate as well to investors' portfolios.

The main reason is that people tend to quote stock market returns (e.g. 150% gain from 10 years ago), but rarely do investors dump in their full investable amount in one shot. Rather, they slowly accrue investable cash over time, and they can only decide at that time how they want to deploy that cash.

Below I've simulated 3 portfolios: (1) a buy-on-the-dip strategy, (2) using dollar-cost averaging, and (3) simply not investing the cash.

Each start out with 10k investable cash, and accrue $50 of investable cash every trading day (≈ setting aside 1k each month to invest). The investable instrument is the S&P index.

For simplicity, dividends are not included in the returns, and this is offset by the cash portfolio not being invested in bonds. One of the reasons for simplicity is that this is not meant to be a research piece on how we should invest, but rather just to give a sense of what investing looks like in reality, with an appreciation of its worst-of-times where being fully invested over 15 years can approach the gains obtained by simply doing nothing (can you stomach that?).

 

Summary of findings:

  1. For the past 30 years, the difference between being invested vs doing nothing is only evident in the 12-year super bull run of 2009-2020
  2. Before that (from 1990 to 2008) any gains were largely wiped out by the downturns of the 2000 and 2008 (depending on when you started)
  3. DCA introduces more risk because it stays fully invested throughout, but yields better total returns; the Sharpe however is slightly lower than the buy-the-dip strategy (but the different is not big and retail investors like us rarely care for such a small difference in Sharpe; total returns to us is more of a priority)
  4. Comparing dollar-cost-averaging and buy-the-dip: in very bad downturns (2008), the decades of gains using the DCA can be easily wiped out, and strategy total returns can be the same as BTD
  5. Depending on when you started, the drawdowns have different impact (how much strategies 1 and 2 loses compared to the all-cash portfolio)

What this means:

  • Widen your range of expectations for future market returns (next 30 years), as we don't know if we can get the same 12-year bull run we had. Be prepared that investment returns may not be as good for the next 20 years or so.
  • There is no universal strategy that is better - see below charts to get a sense of the variabiliy of 'which strategy is better' - see how starting at different times can change your conclusions. That's just one variable; others are: initial capital, how to BTD, and most importantly what is the magnitude of the next bull run.
  • Stay invested anyway - the degree to that (full DCA or BTD) is up to you -  your psychological comfort and anticipated circumstances

 

Parameters:

  • Start with $10,000 cash, immediately invest to the target equity ratio (e.g. 70% equity)
  • Daily inflow of $50; if DCA, invest immediately, if not, save it for the next dip
  • If actual equity ratio is higher than target equity ratio, wait for next market recovery (makes new all-time-highs) to unwind (sell) equity positions at a rate of 0.1% of entire equity portfolio every day, and stop unwinding if market dips down again (back to buying mode)
  • Charts start at 1990, 1995, 2000, and 2005

Charts:

Grey line: dollar-cost-averaging strategy
Black line: total portfolio value of equities (blue) and cash (dark green)
Lime green line: cash-only portfolio

From 1990

Notice how all 3 strategies go back to square 1 in 2008

From 1995

Now, both equity strategies fare worse than cash in 2008 just because we started 5 years late

From 2000

A worse picture

From 2005

Needles to show starting at 2010 - would have been spectacular