My dear Friends,

for the past few months, wealth advisors worldwide have kept telling their clients to hold more cash. Remember, a while ago, the same wealth advisors told us not to hold too much cash, as this would be bad for our portfolios.

At the same time, most economies suffer from high inflation. One of the fundamentals of finance is that inflation erodes the buying power of money- so having a lot of money does not really make sense, does it?

Does the financial industry really advise us to put cash aside so we can watch how it erodes due to inflation?

Confused? What has changed?

Cash textbook

Holding cash is part of the standard financial textbook advice. As with every other piece of advice – it depends on the ” how much”.

Emergency Fund

It’s wise to set aside some savings for an emergency– usually the equivalent of six months of expenses. An emergency fund allows for unexpected disasters or surprises without having to sell off assets. Being forced to sell assets at an inopportune time could trigger excess taxes and suboptimal returns.

Dry Powder

Some investors keep cash, hoping the perfect investment buying opportunity will come. Careful! Timing the market is never a good idea.

However, keeping a certain amount of cash in the investment pot is smart. It will give you the funds to buy stocks or other assets during the decline.

Bear in mind, however, that no matter how cheap you buy or for how long you hold an investment, there’s always a chance you could get back less than you put in.

Cash facilitates all of an investor’s success, even if it looks like it’s not doing anything for long periods. This is why it is called ” Dry Powder”.

Common Sense

How much cash you hold depends on the size of the portfolio. A rule of thumb strategy may be to allocate around 5% of the portfolio to cash. The overall long-term average is at 4,8%.

Prudent professionals opt for keeping between 10% and 20% on hand. Evidence indicates that the maximum risk/return trade-off occurs around this cash allocation level.

At the end of the day, it is up to the investor who has to make a choice. Over the last few years, I, for my part, had all my money invested. Why? Because of the negative interest rate situation, good stock market returns, and a booming real-estate sector.

I mean it’s just, it’s like oxygen you know, it’s there all the time but if it disappears for a few minutes it’s all over.

Warren Buffet, Berkshire Hathaway

Cash on the Side

There is massive cash on the sidelines as markets suffer through extreme volatility and investors remain skittish. 

Cash as Liquidity reserve

A role cash plays in your portfolio is to serve as a liquidity reserve you can draw from when markets fall, or stock exchanges are closed for months at a time. Under these circumstances, liquidating assets is nearly impossible—you simply can’t turn your investments into real cash at these times.

Cash Is Comfort

Another role of cash in your portfolio is psychological. It can get you to stick with your investment strategy through all sorts of economic, market, and political environments by providing peace of mind. When you look at reference data sets, like the ones put together by Roger Ibbotson, you can peruse historical volatility results for different portfolio compositions.

HNW-Privilege

High-net-worth individuals can hold larger amounts of cash because they

a) already have substantial amounts invested

b) can afford to be more patient in seeking out investment opportunities.

They can wait until markets decline significantly and present an especially attractive investment.

Being Overweight

“Overweight” refers to something taking up more than the usual proportion of your portfolio. Financial advisors may sometimes recommend overweighting cash in your portfolio during a financial crisis or while markets are extremely volatile. Yet, there are important CONs to being cash overweight:

Due to these drawbacks, it’s important to strike a balance. Individuals and businesses need to have enough cash on hand to meet their financial obligations during a cash flow crunch. However, they also must consider the cost of having too much of it.  

“Certainly you are losing some purchasing power with inflation running at 8-plus percent, but… you are taking some money off the table at a risky time for equity markets,”

Peter Tuz, President Chase Investment Counsel

Best Performing Asset Class in 2022

In 2021 and the first few months of 2022, both the stock and bond markets traded at lofty valuations, and investments where quite expensive.

By Q3 2022, cash is king. Investors are piling into cash after a brutal sell-off in financial markets this year triggered trillions of dollars in losses, stamping out enthusiasm for riskier assets. 

Investor Capitulation

With interest rates at record-low worldwide levels, cash has been a bad place for investors to keep their money for some years. But as the market turmoil has weighed heavily on investor and consumer confidence. A growing number of economists are now warning of recession in the coming year.

Investors are nervous, so they are holding larger than usual cash piles to avoid deploying it into terribly volatile markets. There also seems to be an investor capitulation element suggesting that many investors think the big low is still ahead of them.

Interest rate hikes battered the stock markets this year. If investors‘ next move will be to deploy all this cash they’ve amassed while markets are under stress, or if this will lead to a rally in 2023, remains to be seen.

Central Banks

Unfortunately, central banks, especially the Fed, are now faced with a difficult balancing act, made all the harder thanks to the Russia-Ukraine crisis.

Many central bankers around the globe know they should raise the cash rate to combat high inflation, but doing so could send the global economy into a tailspin.

By the way, an event many analysts believe is likely. Actually, the truth is, many countries are already in a recession. Some might be less important players but others, like the EU, are big players in the world economy. Due to globalisation, there will be a pre-programmed trickle-down effect. Central banks, especially the US Fed, might have to change course to avoid a major economic downturn.

Safe place

The fact is cash is a more attractive hideout for investors seeking shelter from market turmoil – even though the highest inflation in forty years has dented its appeal.

Of course, sitting in cash has drawbacks, including the possibility of missing a sudden reversal that raises prices for stocks and bonds.

But storing cash away at the deposit account might not be a good idea either, as most banks still have bank rates around zero or barely above.

Short-term investments still offer some return and are certainly a better option than holding cash in a checking account. Short-term investments minimize risk, but at the cost of potentially higher returns available in the best long-term investments. As a result, you’ll ensure that you have cash when needed instead of squandering the money on a potentially risky investment.

SUGGESTIONS:

–Quick Note–

Being overweight is generally not a good idea, but being cash overweight is really bad, especially with headwinds of inflation. Despite the high volatility in the stock markets, cash is a low-yield investment compared to other options.

Interest rates are still well below the current inflation rates. Whatever central banks decide to do, investors shouldn’t expect inflation rates to come back to pre-pandemic levels anytime soon. In other words, you’re practically guaranteeing a loss of portfolio value if you are cash overweight. 

However, retired investors or freelancers need more cash on the side to prevent asset sales when the economy begins a period of shrinkage- so between 10% – 20% in cash is only playing it safe now.

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