Why do investors cash out?

Firstly, to lock in profits. When an asset's value has significantly exceeded its fair price, it makes sense to secure some of the income. In venture capital deals, this is analogous to a partial exit during the next round of financing. You do not exit completely, but you reduce risk and regain your invested capital.

Secondly, it is a form of risk management. If the macroeconomic environment deteriorates and the portfolio is overly concentrated in volatile instruments, holding cash can mitigate potential losses. This can formally be assessed through expected loss:

Expected loss = probability of a negative scenario × size of potential decline.

For example, if the probability of a recession is estimated at 40% and the potential market decline is 30%, the expected loss would be 10%. In such conditions, a partial transition to cash may be justified.

Furthermore, prepare for new opportunities. During crises, assets are sold at a discount, giving investors with liquidity a competitive advantage. In 2008 and 2020, those who kept cash were able to build high-return portfolios.

Personal financial goals also play a role. If a major purchase is approaching or the investment horizon is shortening, risky assets may be inappropriate. Time works against volatility.

Ultimately, moving into cash is a matter of control. Rather than being subject to the market, you are managing your exposure because preserving capital is just as important as growing it. Those who ignore the cycle phase usually pay a high price for it.

What are the market signals that it's time to cash out?

Market overheating

This occurs when asset prices rise faster than their initial value. The main sign of this is an increase in multiples without a proportional rise in profits. For example, if companies show 5% revenue growth and their shares rise in price by 40%, this is a sign of imbalance.

One practical approach is to compare the EV/Revenue multiplier with historical averages. If the ratio is double the industry average, this is a cause for concern.

However, overheating does not necessarily lead to an immediate collapse. Markets can remain irrational for longer than expected. Still, it is precisely during this phase that it is advisable to secure some profits and increase liquidity.

Yield curve inversion

The yield curve reflects the difference in yields between short- and long-term government bonds. Long-term securities yield more under normal conditions. Inversion occurs when short-term rates exceed long-term rates. The spread is formally calculated as follows:

Spread = 10-year bond yield – 2-year bond yield

If the value becomes negative, this has historically preceded recessions, as the market anticipates an economic slowdown and lower interest rates.

Increased volatility

Volatility reflects the amplitude of price fluctuations. It is often measured by standard deviation or the VIX index. The standard deviation formula is based on the deviation of returns from the mean.

A sharp increase in volatility indicates uncertainty. For a portfolio, this means an added risk of decline. In such a situation, reducing the proportion of risky assets and increasing cash holdings can help stabilise the outcome.

Tightening of monetary policy

When the central bank raises the discount rate, the cost of capital rises, which affects the discounted value of future cash flow. In simplified terms, the formula looks like this:

PV = CF / (1 + r)^n

PV is the present value, CF is the future cash flow, r is the discount rate, and n is the time frame.

As r increases, the current valuation of assets decreases. This is why growing companies are particularly sensitive to tight monetary policy.

Mass investor optimism

When the media is full of stories about getting rich quickly and new investors are entering the market en masse without analysing the risks, a behavioural bubble forms. Typical symptoms include a sentiment index, growth in margin lending and a surge in IPOs.

Rational investors remember that the market is cyclical. Rather than being an escape, cash provides a strategic pause before the next phase of opportunities.

Macroeconomic indicators

Inflation

Inflation is defined as an increase in the general price level within an economy. It has a dual effect on investors. Moderate inflation accompanies economic growth. However, high inflation can erode purchasing power and force central banks to raise interest rates. The real return on an investment can be calculated as follows:

Real return ≈ Nominal return – Inflation rate

For example, if a portfolio yields 12% per annum and inflation is 8%, the real capital gain is only about 4%. During periods of high inflation, many assets appear profitable in nominal terms, but do not actually increase wealth.

When inflation gets out of control, the value of risky assets often decreases. During such periods, partially transitioning to cash can help you maintain your purchasing power while you wait for monetary policy to stabilise.

Interest rates

An interest rate is the price of money. It has a direct impact on asset valuation because it involves the discounting of future cash flows. The basic valuation formula is:

PV = CF / (1 + r)^n, where r is the discount rate.

The higher the rate, the lower the present value of future income. This is why rising rates hit technology and venture capital companies, which are expected to generate profits in the future, particularly hard.

For example, if the expected cash flow in five years is $1,000,000 at a discount rate of 5%, its present value is approximately $783,000. At 10%, however, it would be worth around $621,000. The difference is significant.

When the central bank begins a cycle of rate hikes, investors should reduce their exposure to capital-cost-sensitive assets while increasing liquidity.

GDP and recession

Gross domestic product (GDP) reflects the total volume of production in the economy. The calculation formula is:

GDP = C + I + G + (X – M)

C is consumption, I stands for investment, G is government spending, and X – M is net exports.

If GDP grows steadily, the business environment is favourable. If there is a decline for two consecutive quarters, this is considered a technical recession.

During a recession, investment declines, consumer demand falls, and corporate profits shrink. For the stock and venture capital markets, this puts pressure on valuations.

Exiting to cash at the beginning of a recession allows you to avoid significant losses and preserve resources for the next growth phase.

Unemployment

The unemployment rate reflects the state of the labour market and is an indicator of economic activity. Low unemployment indicates a strong economy, but it can also cause inflationary pressure due to wage growth.

A sharp rise in unemployment often signals the start of an economic downturn. Companies cut costs, consumer demand declines, and corporate profits fall.

Investors should assess the trend rather than a single indicator value. If unemployment begins to rise amid slowing GDP and tight monetary policy, this indicates increased risk.

Technical signals to cash out

Breakout of long-term trends

A long-term trend is the direction in which the price moves over months or years. The easiest way to determine this is to use moving averages. For example, the 200-day moving average (MA200) is frequently used to assess the global trend. The formula for a simple moving average (SMA) is:

SMA = (P₁ + P₂ + … + Pₙ) / n

P is the price for the period, and n is the number of periods.

If the price consistently remains above the MA200, the market is in an uptrend. A break below this line, especially when confirmed by volume, typically signals a phase change.

Historically, deep bear markets have begun precisely after indices have consolidated below long-term averages. This does not necessarily lead to an immediate crash, but the likelihood of a further decline increases.

This is a signal to investors to reduce their risk exposure. Exiting partially to cash after a breakout allows you to avoid significant drawdowns if the decline deepens.

Bearish patterns

Chart patterns reflect market psychology. Bearish patterns form when buyers lose strength, and sellers gradually take control.

Classic examples include the 'double top', 'head and shoulders' and 'descending triangle'. The 'head and shoulders' pattern, for example, consists of three peaks, with the central one higher than the others. The line connecting the peaks is called the 'neckline'. A break below this line confirms a reversal.

The theoretical target for the subsequent decline is often calculated as the distance from the top of the 'head' to the neckline, measured downwards after the breakout.

While such patterns do not guarantee a decline, they statistically increase the likelihood of a trend reversal. If a bearish pattern forms after a prolonged rise and is accompanied by high trading volumes, the risk of a correction increases.

Indicator divergences

A divergence occurs when the price reaches a new high, but the momentum indicator does not confirm this. The RSI and MACD are the most commonly used indicators. The RSI is calculated as follows:

RSI = 100 – [100 / (1 + RS)]

RS is the ratio of the average increase to the average decrease over the period.

If the price forms a new high but the RSI shows a lower high, this is a bearish divergence. This indicates a weakening of growth momentum.

Divergence does not necessarily mean an immediate reversal, but it does suggest that the trend is losing momentum. When combined with a breakout of support or increased volatility, it reinforces the need for caution.

Trading volumes

Volume is the number of shares or contracts sold over a given period. It shows its movement's strength. A price increase on low volumes often indicates weak buyer interest. A decline in high volumes signals a mass exit.

The simple principle is that the trend must be confirmed by volume. If the index is falling and volume is rising, it suggests that sellers are dominating. This may indicate the beginning of a systematic decline.

There are indicators, such as On-Balance Volume (OBV), which accumulate volume depending on the direction of price movement. If OBV declines even when the price is high, this is a hidden signal of weakness.

In venture thinking, this behaviour is analogous to that of large players. When institutional investors start to exit, it is reflected in trading volume.

Volume is the voice of capital. If it indicates a decline in interest in risky assets, then preserving liquidity is a sound decision.

Fundamental reasons for moving into cash

Every so often, the decision to move into cash is not dictated by emotions, but by objective changes in the economy or market. Investors assess fundamental factors — that is, the underlying reasons affecting the profitability of companies, sectors, or the market as a whole.

The first sign of this is a significant deterioration in macroeconomic conditions, such as rising inflation, tight monetary policy by central banks, falling GDP and the risk of recession. For instance, when the Federal Reserve System raises interest rates sharply, the cost of credit increases, consumption slows, and corporate profits may fall. In such conditions, stocks typically lose their appeal.

The second factor is market overvaluation. If price-to-earnings (P/E) or price-to-sales (P/S) multiples significantly exceed historical averages, this may indicate an overheated market. A classic example is the period leading up to the 2000 dot-com bubble, when investors fled technology stocks in droves due to overinflated expectations.

The third factor is a company's fundamental problems, such as falling revenues, growing debt, declining margins and management scandals. If a company's business model ceases to be competitive, it is better to secure profits or minimise losses and switch to cash.

The investor's personal financial circumstances

Not all decisions to sell assets are market-related. Often, the investor's personal financial situation plays a key role.

For instance, if someone requires funds for a significant purchase, such as real estate, a business, or their children's education, it makes sense to minimise risk and convert part of the portfolio into cash. Investments are a means to an end, not an end in themselves.

A change in risk tolerance is another factor. As people grow older or face life circumstances (e.g., job loss or the birth of a child), they may seek greater stability. What was appropriate at age 30 may be unacceptable at age 55.

Liquidity also plays an important role. It is recommended to have a financial 'cushion' to cover 3–6 months of expenses. If you don't have one, converting some of your assets into cash could be a sensible step.

A full or partial exit to cash

Exiting to cash does not necessarily mean selling your entire portfolio. Investors can choose between a full or partial transition.

A full exit is a radical step, usually taken ahead of a serious crisis or major personal expenses. However, this approach carries the risk of missing out on a rapid market recovery.

A partial exit is a more flexible strategy. For instance, if a portfolio consisted of 80% equities and 20% bonds, an investor could reduce the equities to 50%, thus locking in profits and reducing volatility. This keeps them exposed to potential growth while reducing risk.

Another approach is staggered selling, which involves selling assets in instalments over a set period. This reduces the risk of 'mistiming' the market.

In most cases, a partial exit appears to be a more balanced solution than a complete transition to cash.

Common mistakes when cashing out

The most common mistake is to sell emotionally during a panic. Investors often sell assets at market lows, locking in losses, and then fail to reinvest in time for the market to recover.

The second mistake is trying to guess the lowest and highest points. Even professional fund managers find market timing extremely difficult. Research shows that missing just a few of the best growth days can significantly reduce a portfolio's long-term return.

A third issue is the lack of a clear re-entry strategy. If an investor moves into cash without specific criteria for re-entry, they risk staying out of the market for too long.

Finally, there is the issue of ignoring the tax implications. Selling assets can trigger capital gains tax, reducing actual profits.

Alternatives to going fully to cash

Rather than holding 100% in cash, you can reduce risk by investing in fixed-income instruments or by rebalancing your portfolio.

Another option is to gradually reduce your holdings. For example, if you sell 10% of your risky assets each quarter, you reduce your dependence on a single entry or exit point.

The key idea is simple: while cash is a protective tool, your risk management strategy should be multi-layered. Rational investors do not seek absolute security, but rather a balance between protection and growth potential.