The 4-Letter “C” Word for Investors: Cash

Posted by Brad McMillan, CFA, CAIA, MAI

Find me on:

This entry was posted on Aug 17, 2017 1:33:01 PM

and tagged Investing

Leave a comment

cashRecently, many readers have asked me about where the market is, as they are worried about what to do with their portfolios. The gentleman behind the grill at the café where I get breakfast, who knows what I do, has the same questions for me. Advisors want to know what I think about gold as a risk reducer. Almost every day for the past couple of weeks, I have heard about the nervousness. People are getting scared.

What’s causing the fear?

Part of this is seasonal. August and September are notoriously the weakest months for the market, and people react to that. Part of it is a response to real uncertainty, with North Korea and the latest round of controversy from Washington. And part of it, frankly, is probably due to people like me, who have been vocally worrying about how expensive the market is. I plead guilty on that last one. Although, as I noted in this month’s market risk update, the risks are high but don’t look to be immediate.

But no matter where the fear comes from, the takeaway is that many investors have moved too far out on the risk curve, and their portfolios are no longer in the right place for their peace of mind. With the recent appreciation in the stock market, it is easy to see how gains could push your stock allocation up to a level you are not comfortable with—and how you could start to fear losing them.

About that “c” word

Which brings us to the use of the “c” word. In the investment context, that word is “cash,” which is usually a four-letter word not only literally but also metaphorically. Cash in a portfolio is generally seen as wasted space, guaranteed to lose purchasing power over time as inflation creeps up and to miss the gains that usually come from financial investments.

On an institutional or long-term basis, these criticisms of cash are dead on. The opportunity cost and inflation cost are very real. Over time, it is certainly best to keep your money invested. Shorter term, and when risk levels are perceived to be high, however, the arguments against cash are not so clear.

Does increasing your cash allocation make sense?

Given the situation today, if an investor is worried, a larger allocation to cash might make sense. With interest rates so low, the return forgone from bonds is quite low by historical standards. Plus, with stock prices so high, the downside risk is quite high by historical standards, and the future expected returns are low. From an investment perspective, then, the argument against cash is weaker than it has been for decades.

The argument for cash is also stronger. Having more cash in your portfolio can help you sleep at night. It can give you the freedom to ignore market downturns, at least for a while, as you can spend the cash down rather than sell stocks at low prices. Last but not least, in the event of a drawdown, it lets you invest that cash at higher expected yields and returns. Right now, for many investors, increasing the cash allocation in their portfolios is a reasonable option.

Peace of mind

You don’t want to overdo it, of course, and you certainly want to keep it as a smallish part of your portfolio. The opportunity costs and inflation drag are very real. Over time, too much cash can really hurt your results. For right now, though, adding some more cash could offer real benefits if you are worried. Peace of mind and the ability to stay the course are critical in investing. It is better to keep your portfolio at a comfortable level that you can live with, rather than being aggressive and then pulling out at the wrong time.

Subscribe via E-mail

New call-to-action
Crash-Test Investing
Commonwealth Independent Advisor

Hot Topics

Have a Question?

New Call-to-action

Conversations

Archives

see all

Subscribe

Disclosure

The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly into an index.

The MSCI EAFE Index (Europe, Australasia, Far East) is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.  

Third party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided at these websites. Information on such sites, including third party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

Member FINRASIPC

Please review our Terms of Use

Commonwealth Financial Network®