What does one typically use as a money reservoir for stocks, when they are "on sale"?

Question

I've read about people who claim to have made a lot of money investing in stocks (or funds) after a crash. They say the stocks were "on sale".

But I wonder, where did they get the money to buy these stocks?

Certainly they didn't use their emergency fund (which would be foolish)?

Did they change their stock/to bond allocation (which might also be foolish)?

Did they have a bunch of money just sitting around for the event, and hence not earning much of anything in the mean time, betting (potentially foolishly) that a crash would come?

Where do people get the money to suck up stocks during a crash?

Answer 1

TL;DR: Cash is king — and bonds are not cash.

I've written about this in this other answer. Here's part of it:

[...] inflation aside, why do we want our "equivalent to cash" position to be relatively liquid and principal-protected?

When it comes time to rebalance your portfolio after disastrous equity and/or bond returns, you've got in your cash component some excess weighting since it was unaffected by the disastrous performance.

That excess cash is ready to be deployed to purchase equities and/or bonds at the lower current prices. Rebalancing from cash can add a bonus to your returns and smooth volatility. If you have no cash component and only equities and bonds, you have no money to deploy when both equities and bonds are depressed. You didn't keep any powder dry. And, BTW, I would personally keep a bit more than 3% of my powder dry.

I'll add that: Yes, one could in theory also sell some bonds to buy some stocks — and if the bonds aren't also depressed in price, then that could be a sensible move.

But! One should only sell bonds to the extent that it is a rebalancing from bonds into stock, i.e. back to the pre-crash target weights for each in the portfolio that originally made sense and, presumably, still make sense.

I think you're right to suggest that changing one's stock/bond allocation (as in: changing the target weights for each in the portfolio) could be foolish. But if stocks dropped, say, 50% while bonds held most of their value, then one has probably become overweight in bonds and could rebalance some into stocks. Some.

I'll add: When could cash get replenished? If you're still in your accumulating phase of life, cash can grow when you make subsequent contributions. And whether or not you are still contributing, your investments would likely yield interest, dividends, or other cash distributions. Otherwise, reallocating back to some cash might be something scheduled for when the market has recovered some, e.g. say when your portfolio gets back to pre-crash levels.

Answer 2

A lot of people (and it's common advice) only have x% of their portfolio invested at any given time. Depending on your tolerance for risk, you might leave 10-30% in cash/money market, for example. Also, if you're still earning and saving, that amount of cash will grow every month as you continue to grow your nest egg.

That's where the money comes from.

Answer 3

Your question is based on the assumption that all investors hold their stocks during a 'crash' and therefore they have a limited amount of cash available during it. That assumption does not apply to everyone.

It's important to distinguish between a crash and a bear market. Market crashes such as 1929 and 1987 are rare and if one is fully invested during one (maximum "X" % allocation), you take the full beating unless you have some form of hedging in place.

Bear markets like 2000 and 2008 took 18 months to unfold so they offered lots of time to react and adjust. If one is more market savvy, cash is accumulated by profiting from the market correction (short positions, long puts, inverse ETFs, etc.).

In both cases, there will be some cash accumulation due to dividends and that can be reinvested at lower prices but that's simply dollar cost averaging. You won't make a lot of money from that piece of your portfolio.

Answer 4

Assume that you have a regular income, with enough left over after living expenses that you can save or invest. Also assume that you think the market currently is over-priced*, so that you've been saving that excess as "cash" - which isn't necessarily money stuffed under the mattress.

Now the market takes a steep drop, as it did in '08-09. Here you are with a pile of cash, and (assuming your job didn't go away) more coming in. So you cut your living expenses to the bone, and when you figure that the market is near bottom (or in my case, starting to recover), you invest all that cash.

*Wouldn't it be foolish to invest in a market you think is over-priced?

Answer 5

Also, some of those people are traders of some kind (mostly swing/longer term, but still). Guess what - as a trader, it is totally ok to be in cash because that is your default position. You only take market risk if you see a market chance.

Did they have a bunch of money just sitting around for the event, and hence not earning much of anything in the mean time, betting (potentially foolishly) that a crash would come?

Pretty much yes. There is nothing foolish in being all cash if you see no better choice, or to move into low income low volatility assets (TBills).

Definitely not foolish if you have a track record of making a lot of money.

Answer 6

You use the cash part of your portfolio

A well balanced investment isn't all in stocks.

Imagine your policy is to keep 2/3 of your portfolio in stocks ($60000) and 1/3 in cashlikes ($30000). Stocks lose half their value, your stocks are now worth $30,000.

To get back to 2/3-1/3, you will need to buy $10,000 in stocks so you now have $40k in stocks and $20k in cashlikes. That's not even a genius plan to "buy on sale", that's just rebalancing your portfolio. That's normal.

When the market recovers to what it was before, you now have $80k in stock and $20k in bonds. You only had $90k before.

Now you need to rebalance again, to $66666/$33333, to adhere to your policy.

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Now if you're actually exploiting the half-off sale, you would buy more stock, so you have $60k of stocks and $0 of cashlikes. Then when the stocks recover, you have $120k.

Answer 7

Certainly they didn't use their emergency fund (which would be foolish)?

A better term would be "contingency fund". You should have some money set aside in case something comes up. That's not always going to be an "emergency".

Did they change their stock/to bond allocation (which might also be foolish)?

If stocks are undervalued, then it's not foolish to overemphasize them. The more undervalued an asset is, the more you should be willing to expose yourself to higher variance to take advantage of it.

Also, cash can be freed up by increasing one's leverage.

None of this addresses whether one's belief that stocks are undervalued should trump the EMH.

Answer 8

Typically, you just borrow against your existing positions. If that leaves you with more leverage than you want to have, you sell some portion of some of your existing positions. With interest rates as low as they are now, there's usually no rush to adjust unless you have some positions you want to reduce.

Answer 9

I suspect this is just a form of "survivorship bias". Some people had money ready at the right time and became noted for pulling off a bargain purchase of some stocks. That ignores scores of other people who couldn't take advantage of the opportunity, even if they wanted to; those others are simply not noted for any success in connection with that market event. History doesn't record the could nots and did nots.

At any point in time, there are people with ready cash, about to do something with it, and there come times when bargains are available.