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.
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.
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.
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.