Why Cash Has a Place in Every Investment Portfolio
by Adam Hanafi
Posted on February 01, 2019 at 10:45 PM
Cash often earns lower rates than other asset types, but it can still hold a place among your investments.
Although it may sound counterintuitive at first, cash has a role in every diversified investment portfolio. For one thing, cash can add some much-needed stability to your finances. In addition, some amount of cash is important to have during a market correction, since it allows you to buy more investments at bargain prices.
An adequate cash reserve can also help you weather life’s inevitable ups and downs. A general rule of thumb is that, if possible, a household with one income should keep a cash reserve equal to 6 months’ earnings on hand to withstand a temporary shock like a job loss or an uninsured medical expense. A household with two incomes may be able to reduce this cushion to 3 months’ earnings.
What is Considered "Cash"?
The term “cash” is actually broader than many people realize. It refers to currency, coins, bank notes and accounts you can quickly cash out if needed. Savings and checking accounts fall into the cash category. This financial category also includes “cash equivalents”—money market accounts and very short-term bonds or certificates of deposit. These accounts don’t change much in value so they function a lot like cash.
The Case for Cash
Cash and cash-equivalents typically earn less than stocks. That’s one reason some investors tend to snub them. However, cash also offers some big advantages.
For instance, cash and their equivalents:
• Add stability to your portfolio:
Cash is steady and stable. Its value doesn’t fluctuate up and down much. Investors typically don’t lose money in their cash accounts. This stability can be very valuable during a volatile financial market.
• Let you take advantage of investment “sales”:
When stock and stock fund prices drop dramatically during a market dip, equities are essentially “on sale.” Smart investors take advantage of this bargain-hunting period by buying equities when they’re at a good price. Investors who already have a portion of their portfolio easily accessible in cash are in a good position to take advantage of these types of investment “sales.” Having cash can help you follow famed investor Warren Buffett’s advice to be “fearful when others are greedy and greedy when others are fearful.”
• Are paying more interest and are of higher quality:
Rising interest rates means investors now have the chance to earn a real return (above the rate of inflation) on their cash for the first time in almost a decade. In addition, investors don’t necessarily have to sacrifice the quality of their bonds to earn higher rates. They can again consider solid products like U.S. Treasuries and even very short-term bonds and earn a reasonable rate.
A Balanced Approach to Portfolio Allocation
Of course, there are risks to keeping too much of your portfolio in cash. If you get too comfortable with cash, you could miss out on potential stock market gains. Also, if you have too much of your portfolio in low-earning cash and cash equivalents, you could face the risk of your money not keeping up with inflation and losing purchasing power over time.
Good balance is key. N.C. Capital advisors typically allocate at least 64.3% to cash and its equivalents. However, depending on how risky of a investor you are, you should consider rebalancing your portfolio -- especially if it has wobbled out of its target levels during recent market shifts. You might then consider transferring some of your investment proceeds into bonds and other cash options.
Regardless of how the financial markets shift, cash will always hold an important role in every investor’s financial life.