Why Hold Cash?
With interest rates near historic lows, clients often wonder why we are holding cash in their investment accounts. A common question is “Wouldn’t it be better to put that money into stocks so I am earning something on my money?” This may seem logical, but cash plays several important roles in an investment portfolio.
Cash reduces risk
Cash reduces the overall risk of a portfolio. Yes it is true that cash can also reduce overall return when markets are going up, but it can provide much needed protection by reducing down-side risk in a market decline. Cash helps temper portfolio swings which may help keep investors from making irrational decisions to sell securities when markets drop.
The amount of cash an investor should hold varies from person to person and is determined by evaluating your personal situation. Several things should be taken into account including time horizon, overall risk tolerance, and total assets to name a few. In most cases cash should not be the primary holding, but a part of a well balanced portfolio designed to help meet your investment needs.
Cash provides liquidity
Cash gives investors the ability to pay obligations when the need arises. It can provide the means to cover an unforeseen expense without having to liquidate investment holdings at an inopportune time. After all, the water heater and furnace never seem to need replacing when the market is at all-time highs.
It is important not to invest money in the market if there is a chance you may need it in the near future. This money should be set aside in an investment vehicle that has little or no risk and is accessible on very short notice.
Cash provides opportunity
When the market goes through a period of volatility, you may be presented with an opportunity to invest in a security that is experiencing a temporary sell off. Having cash on hand allows you to take advantage of these opportunities without the need to liquidate your other investments to do so, especially at a time when your own investments may also be experiencing similar pressure.
Cash provides comfort
Over the years I have seen investors make many mistakes and rash decisions when the pressure is on. I have seen how critical cash is to controlling risk within a portfolio, and how it often helps prevent irrational behavior.
Having cash available to draw from in an emergency or to take advantage of an opportunity is reassuring and seeing your portfolio behave in a less volatile way during market swings reduces anxiety. Having the right allocation of cash is often the key to remaining comfortable and engaged throughout a variety of market conditions.