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Noisy Fallacies

Clear thinking is a necessary component of successful investing, but some fallacies can be difficult to detect. Here is a common example.

A recent segment on CNBC titled “What Happens if $6T in Cash on the Sidelines Comes Into the Market?” discussed the potential implications of $6 trillion of cash “flowing into equities.” The speculative debate included comments that suggested the cash would result in “pushing [equity] markets higher” and “fueling stock gains.”

This sounds plausible on the surface, but, in reality, there is no sideline in the markets, and cash cannot flow into equities in the way implied.

Sure, you or I can hold cash we plan to deploy into equities (for this discussion cash includes money market holdings). Clients may know we sometimes employ what is called “dollar cost averaging.” Dollar cost averaging involves investing into markets over time to limit the risk of, say, purchasing right before a market downturn. One could call this deployment of cash from the “sideline” for an individual investor. In aggregate, however, there is no such thing.

To understand this, think about what happens when the investor buys $100 of equities with cash.  That $100 leaves her cash holdings and is traded for stock. On the other side of this, the seller has $100 less in stock holdings and $100 more in cash.  In total, nothing has changed. There is the same amount of money in cash and equities. This is the case no matter how much equities rise or fall in value; the amount of an equity purchase always equals the amount of a sale (minus transaction costs). Any money that flows into equities from a buyer is offset by the money that has flowed out of equities to the seller.

Yes, money can flow into individual funds such as a mutual fund. But from there, it’s the same as the example above. If the mutual fund holds cash, it’s still on the sideline. If the fund purchases equities, the seller receives that cash and the net is zero.

This matters because clear thinking on this better enables one to think rationally about investing and rise above the din of the financial punditry. It can eliminate the impulse to, for instance, get ahead of the supposed cash that will be flowing into the market. It also enables one to ignore statements about all the “selling on Wall Street” on a down day (there’s just as much buying as selling no matter the day). “Bargain hunting” is often used to characterize an up day. “Profit taking” is used to describe a down day. Those frequent descriptions ignore the other side of the trade. For every “profit-taking” investor, there is a “bargain hunting” match on the other side of the trade, no matter the direction of the market. 

Understanding these errors in reason helps investors focus on what is most important to long-term investing success. In its simplest form: make a thoughtful plan and stick with it. Ignore the noise and focus on goals.

Jeff Buck