There’s an old saying in financial circles is that “cash is king.” The actual meaning of this phrase varies depending on the context. Some investors appeared to buy into this philosophy during the market’s turbulent period from 2007 to 2009, and moved significant sums of money out of stock and bond investments and into cash-equivalent holdings like money market funds and bank CDs. That may have provided some short-term protection. But, as many are finding out in light of the stock market’s recovery over the last five years, holding too cash can have a negative effect on long-term investment results.
Cash can be an effective tool within a portfolio – but typically when used in a strategic way to help achieve long-term goals, not as a hiding place when the market is going through its inevitable downturns. The appropriate role for cash in your portfolio should be dictated by your investment goals. Here are some guidelines.
Cash during your accumulation years
If you have years to let your money grow to meet future needs (retirement, college, costs for your children), cash may play only a minor role in your portfolio. The appropriate percentage depends on your circumstances.
One way people choose to invest their cash is by dollar cost averaging. Instead of investing a single lump sum all at once, you invest smaller amounts of money at regular intervals (no matter how the market is performing). Dollar cost averaging can’t guarantee a profit or protect against a loss in a declining market. But, over time your average cost per share is likely to be less than the average market share price.
Cash for an income portfolio
Cash will typically play a more significant role for those in retirement who are drawing income from their portfolio. The key, just as with someone in the accumulation phase of life, is to manage cash appropriately. Given today’s low yields on money market funds and CDs, keeping too much money in cash may limit the amount of income you can afford to withdraw from your portfolio.
One approach is to place a portion of your portfolio into cash or other short-term investments that have little or no risk of fluctuating in value. Another strategy is to set aside enough money to meet two-to-three years of income needs (in addition to other sources of income you have such as Social Security or a pension).
Many people find that actively investing some of their money in the market may help them keep up with inflation or provide extra income. But, it varies for everyone. The types of investments you have and how much you choose to invest depends on your situation.
In today’s low interest rate environment, it is more important than ever that you pay close to attention to the percentage of your assets held in cash-equivalent investments. Think about meeting with a local financial advisor to determine how to best manage the cash in your portfolio.