The Pros and Cons of Going to Cash

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One of the most common questions I get from readers is how much of their portfolio they should keep in cash.

How Much of Your Portfolio Should Be in Cash?And my answer is always the same: It depends!

The amount of cash you should have on hand depends on a handful of factors:

  1. What is the investment strategy of the account?
  2. What other funds do you maintain outside of the brokerage account?
  3. What is your time horizon, and what are your foreseeable cash needs?

What is the investment strategy of the account?

Let’s start with the question of investment strategy. Most investors, particularly those invested in a standard asset allocation, will be more or less 100% invested at all times, meaning they keep no cash on had at all. But if you’re an aggressive trader, a market timer or a disciplined valued investor, it might be OK for you to keep as much as 50%-100% of your portfolio in cash at any given time.

Renowned value investor Seth Klarman is famous for maintaining a large cash position, often as much as half of his portfolio. He likes to keep his powder dry for particularly good opportunities when they come along.

Likewise, Warren Buffett’s Berkshire Hathaway Inc. (BRK.A, BRK.B) regularly has gargantuan sums of cash on its balance sheet to be ready to deploy whenever Buffett finds an “elephant” to hunt.

If you trade opportunistically, then it’s perfectly fine to follow the leads of these great value investors. But keep in mind, cash sitting on the sidelines will be a drag on your portfolio in a bull market. And most of us lack Buffett and Klarman’s investing prowess. Plus in many cases, such as a 401k plan to which you are currently contributing, you are constantly adding fresh cash with each paycheck, so there is much less need to keep cash on hand. You are dollar cost averaging, automatically buying the dips.

What other funds do you maintain outside of the brokerage account?

The amount of cash you keep in your portfolio will also depend on how much cash you keep outside of your portfolio. If you regularly keep an extra-large cash cushion in your checking account, then you can afford to invest a little more aggressively and keep a lot less in cash. If the market craters, and you want to use it as an opportunity to buy the dip, you can always transfer some of your rainy day cash to your brokerage account.

But if you’re a little light on outside savings, you might want to keep your portfolio a little cash-heavier than usual. As a general rule, I recommend separating “investment cash” from “rainy-day cash.” It’s OK to move money back and forth when you have unusual cash needs, but as a general rule it’s better to keep the two separate. The investment cash is something to be deployed in pursuit or profit. The rainy-day cash is there to take care of you in the event of a short-term emergency.

What is your time horizon, and what are your foreseeable cash needs?

And finally, we get to issue of time horizon. If you have immediate cash needs — such as for a house down payment or to pay for your child’s college expenses — it makes sense to keep those funds liquid, in cold hard cash. It would be Murphy’s Law that that market would crash on you right before you sold and took out the cash, so don’t put yourself in that position. For any expenses you foresee in the next 1-2 years, keep the funds in cash.

But on the flip side, if you have no immediate cash needs, keeping the funds in cash will do nothing more than water down your returns. It makes a lot more sense to keep it invested.

So again, the question of how much cash you need in your portfolio will really depend on your circumstances. But you should remember that there are risk with holding too much cash or not enough. Your risk of holding too much cash is that of opportunity cost. You could have made more money by investing the funds more aggressively. But risk of keeping too little in cash is that you’ll be unable to take advantage of opportunities when they come along or that you might not have funds you need in the event of an emergency.

Check out our full checklist if you haven’t already, or tab back over to the checklist to see other ways you can clean up your portfolio.

Charles Sizemore is the principal of Sizemore Capital, a wealth management firm in Dallas, Texas.


Article printed from InvestorPlace Media, https://investorplace.com/2016/04/how-much-portfolio-cash/.

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