In times like these, with stocks hovering in record territory and on the heels of multi-year gains, holding a position in cash can seem downright counterproductive. By being fully invested in the market, you put yourself in a position to maximize your gains from the historic run-up in prices.
Cash can’t give you the kind of dramatic returns that stock can, but it’s not always about return on investment — it’s more of a strategic investment play.
And cash can be an investor’s best friend in times of trouble.
Cash is a Fundamental Part of a Well-Diversified Portfolio
Cash is a basic component of a typical portfolio. The mantra of being “fully invested” that develops, and becomes an article of faith in bull markets, doesn’t and shouldn’t exclude cash from your portfolio allocation. In fact quite the opposite — bull markets are an excellent time to build your cash position for future investments.
Raise Cash Without Selling Current Positions
One of the advantages of having a reasonable cash allocation is that it available when you need it — without having to sell current investments to make it happen. Cash helps you maintain your investment allocations on a consistent basis.
If you have to sell investments to raise cash, you can almost bet the timing will be wrong. You’ll most likely sell your poor performing stocks — after all, they’re performing poorly. But when you do, you’ll lock in your losses on those stocks and cash can prevent that from happening.
Give Yourself a Personal Cushion
It is often not possible to completely separate your investment portfolio from the rest of your life. There may be times when you’ll have to access some of your portfolio for personal reasons. So unless you have at least some of your portfolio in cash, you will be forced to liquidate productive investment assets.
Cash in a portfolio can operate as something of a buffer between your portfolio and your personal life. Sure, you should have other sources of cash — such as an emergency fund — but we all know our plans and reality don’t always flow in perfect harmony. Cash provides a personal cushion for those instances.
Bottom-Feeding for Bargains
This is perhaps the best argument for keeping at least some of your portfolio in cash. When you have cash readily available, you are in a position to take advantage of bargain investments as you discover them. You don’t need to decide which investments you need to sell off in order to buy new ones.
This is even more important in bear markets. If you have cash in your portfolio during bull markets, you will already be in position to bottom feed on the bargains that down markets produce by the wheelbarrow full.
There is no way to avoid losses on your stock positions when stocks enter periods of prolonged decline. But you can offset these price declines when buying stocks at, or near, the bottom of the market, then recouping your losses more quickly by riding the elevator back up with a portfolio full of oversold stocks. Cash enables you to do this.
Protection Against Stock Declines and Other Market Surprises
If you are 100% invested in stocks, you may reap 100% of the potential gains that a rising market provides, but you will also expose yourself to 100% of the losses if the market heads south. While that may not bother you on the way up, once the market turns the other way, it will be too late to change your allocation.
Let’s say that in a mature stock market — such as today’s market — you increase your cash position to 20% of your portfolio. Should the market turn into a full-blown bear market, you will have reduced your losses by 20%.
Cash is the very best protection against bear markets because, unlike bonds, there’s no chance it can lose value for all the same reasons stocks will.
Follow the Lead of Experts
If you look at major portfolio managers — mutual funds, pension funds and the like — they always have at least some money sitting in cash. This is true even in funds classified as “aggressive”. The reason is simple: cash is a portfolio management tool, and one you shouldn’t attempt to be without.
As individual investors, we shouldn’t be trying to reinvent the wheel. If big time investment portfolio managers keep cash positions, we need to do the same.
Do you regularly hold at least some of your portfolio in cash? If so, how much do you think is reasonable, especially in the current market environment?