This article is original content written by Manchester, CT Financial Advisor Thomas Scanlon, CFP®, CPA
The rates of return on cash (checking, savings, and money market) are very close to zero. This begs the question, “Why have any cash in the portfolio?” Some commentators have even suggested that “Cash is Trash.” I disagree.
Cash Reserve Fund
The first thing investors should do is fund their cash reserve fund. This fund can be accessed when an emergency arises. This emergency could be unexpected medical expenses or perhaps you lose your job. The popular media maintains that investors should have at least six months of living expenses. Our experience is that most investors have three months or less in their cash reserve fund. Although your cash reserve fund is an asset and part of your net-worth it’s not considered part of your investment portfolio as you are not investing it.
Depending on an investor’s timeline and objectives, a typical portfolio may have 5%-10% allocated to cash. This provides a buffer to the portfolio. Additionally this cash is liquid if funds were needed and provided dry powder if a buying opportunity presents itself. Before the Great Recession of 2008-2009 you might be able to get 3%-4% return on your cash. (1) Today it is essentially zero.
Cash is King
Even with rates of return on cash near zero it is important to maintain cash in your investment portfolio. Having cash is crucial when buying opportunity comes along. And buying opportunities will come along. You just have to be patient. A Stock Market ‘Correction’ is defined as a pullback of at least 10%. As of January 2020, the last time the Dow Jones Industrial Average (“Dow”) had a decline of 10% was in the first quarter 2020. (2)
Short-term interest rates won’t stay near zero forever. The Federal Reserve (“Fed”) has made indications it will raise rates when it is deemed appropriate. When will this be? Who knows.
How much cash that is allocated in your investment portfolio needs to be taken within the context of your overall asset allocation.
(1) Reuters
(2) https://en.wikipedia.org/wiki/list_of_stock_market_crashes_and_bear_markets
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