Do you have enough cash in your portfolio?Submitted by Mission Financial Planning on November 13th, 2020
People are generally holding more cash than usual right now, having reacted to COVID’s effect on the market and the economy, uncertainty about the election, and the feeling that there’s safety and security in cash.
There can be a nagging feeling that the cash is idle money, particularly with the near zero returns we’re seeing on money market accounts.
Managed appropriately, cash just sitting in an account, appearing to do nothing, can be an important part of your overall strategy.
Emergency fund vs. strategic cash
Setting aside an emergency fund, rainy day fund, or fun money are all good reasons to have cash on hand.
In a dental practice, a cash account can get you through a difficult month or short-term uneven cash flow. We recommend keeping cash on hand of 1.5 times monthly practice expenses.
In your personal life, keeping cash on hand for unexpected or irregular expenses keeps you from running up credit cards and lines of credit or cashing out investments to pay for expenses or events -- good or bad -- that can be anticipated, if not scheduled. It’s recommended that people keep enough cash to cover between 2.5 and 6 months of expenses.
There are also ways to use cash strategically: in lieu of a bond allocation, to moderate risk, to provide a safety net, and in retirement, as a strategic reserve of spending money.
Cash for diversification
With interest rates as low as they are, investors don’t get the returns from a bond allocation like they used to.
With the 10-year Treasury Bond rate at less than 1% (as of 11/10/2020), it’s hard to get excited about making a 10-year commitment. In comparison, money markets (for holding cash) provide similar yields and are immediately available.* Some professional investment managers are using cash where, in more normal times, they would allocate to bonds.
Cash to reduce risk
Cash can be used to mitigate investment losses during downturns. For example, a 20% market decline in a fully invested portfolio results in a loss of 20%. By reducing market exposure to 80% and putting the rest in cash (or otherwise guaranteed fixed value) position, the same downturn results in a portfolio loss of 16%.** Remember though, that to the same extent, cash will reduce positive returns as markets appreciate.
Peace of mind
Cash on hand can also reduce the chance of panic-based selling when markets get volatile. Knowing that there is cash cushioning the downturn, and that money is available in an emergency without cashing something in, allows cooler heads to prevail.
Spending money without selling
For those taking withdrawals from investments for living expenses, cash can provide a strategic reserve of spending money to use instead of having to liquidate investments when the market is down, to avoid spending principal.
Timing the market
When active investors talk about cash, they often compare it to keeping some “dry powder”, having cash ready to invest if the opportunity presents itself.
Be careful of market timing, and remember the “buy low, sell high” strategy. It’s very easy to move to cash out of fear when the market is down, and to follow the buying crowd when a particular stock gets popular. For market timing to work, you have to have the right timing on BOTH the buy and the sell decisions. Moving to cash might help you avoid a market decline, but if you’re not back in the market to catch the upswing your long term performance may suffer. There’s an old adage that I’ve generally found to be true: time in the market beats timing the market.
Warren Buffet has been attributed with this great quote about cash:
"Cash ... is like oxygen. When you don't need it, you don't notice it. When you do need it, it's the only thing you need."
Want to change your percentage of cash?
To reduce your cash position, money can be deployed on market dips or by dollar cost averaging into the market over time. To raise cash, you can systematically trim holdings that have increased in value, or sell positions you no longer believe in. Be careful of the tax implications of selling, you may create a capital gain.
Keeping money in a cash account doesn’t mean it isn’t working for you. Take a look at your portfolio to find the cash and start thinking about it strategically.
Give us a call if you want to get strategic.
*Comparing Treasury Bonds and money markets is not an apples-to-apples comparison, Treasuries are backed by the full faith and credit of the US Government, money markets may not be.
**Different cash allocations will make sense depending on your risk tolerance.