A hoard of cash in your portfolio is always a double-edged sword. It provides security, comfort, and the flexibility to deploy in virtually any asset class at any time.
It also can be a significant drag on your returns if you prolong your stay and cause undue stress with the knowledge that you need to put that money to work.
The more I speak with prospective clients this year, the more I hear that investors have a lot of cash on the sidelines.
Some fear a collapse in stocks or bonds, while others simply don’t have the right tools or discipline to properly invest their money. In both situations, it’s important to identify the issue and take meaningful steps to create some inertia.
Sometimes it’s just overcoming that first small trade before you start to realize that putting the money to work won’t be the end of the world. It will also give you confidence to start critically analyzing your asset allocation and making incremental adjustments to reach your long-term goals.
Unless you just inherited some money or rolled over your 401(k), an overabundance of cash is often a sign that there is no true plan in place.
Waiting on a market correction is not a plan. It’s a form of timing that will likely only be rewarded through luck rather than skill.
Just saying that you are being conservative or cautious right now isn’t a plan either. It’s a justification to support your current condition.
If you were truly conservative, then you would have probably staked out a semi-coherent asset allocation in a small degree of stocks, short duration bonds, or even gold.
I always advise investors who have 50% of their portfolio or more in cash to evaluate their situation, both past and present.
- Did you sell down several highly appreciated positions and are waiting to buy back in?
- Are you uncertain about the election, the Fed, or some other unknowable force?
- What price levels or other factors would trigger you to put this money to work?
- Do you understand the strengths and weaknesses of your current position?
Let’s look at some of the numbers for a minute. Assume you have 50% of your portfolio invested in a 50/50 mix of stocks and bonds.
If the stock allocation gains 10% and the bond allocation gains 4%, that leaves you with a total return of just 3.50%. Some people may be happy with that return. Others would probably look at that number and think they took a decent amount of risk to get just a paltry 3.50%.
You’re asking half of your portfolio to work overtime so that the other half can sit idle and make virtually zero return.
It’s reasonable to assume that active investors will have a somewhat higher cash position than those who are fully invested 100% of the time. It’s not uncommon to see cash positions in the 10-25% range depending on how your investment paradigm aligns with the current market.
However, creeping heavily above that 25% threshold starts to significantly detract from meaningful correlation in stocks, bonds, or commodities.
You run the risk of falling out of step with the existing trend or having the confidence to put money back to work if a correction does materialize.
The bottom line is that everyone’s situation is going to be unique. There is no “perfect” solution for exactly how much cash you should have at any given time.
The key is just to monitor your asset allocation to determine if you are falling into the camp of holding too much cash for too long. It can often lead to disappointing performance results or constant second guessing of unquantifiable risks.
There is always going to be some level of uncertainty with investing. That is part of the risk calculation that can be mitigated through proper diversification and a sensible portfolio management approach. You must also understand that there is no short-cut to prosperity. It will take hard work and a decent amount of time to achieve a successful result.
Until next time,
David Fabian is a Managing Partner at FMD Capital Management, a fee-only registered investment advisory firm specializing in exchange-traded funds. He has years of experience constructing actively managed growth and income portfolios using ETFs. David regularly contributes his views on wealth management in his company blog, podcasts, and special reports.