Like a good friend, one asset will never let you down…
You can always rely on it. And that’s because you’ll always know its return.
Almost every single one of us has had it pounded into our heads that we need to get invested and put our money to work. There’s no doubt I’ve stressed that. But not every single dollar you have needs to be in stocks or bonds.
You always need to hold cash.
Think about this… Professional money managers have no choice but to be fully invested in stocks and bonds. When a hedge fund collects 1% or 2% a year to manage someone’s money, it can’t justify much of a cash holding. An index fund, mutual fund, or exchange-traded fund has to put all of its money to work.
While cash can smooth out returns and pay off over the long term, a professional has to hit annual – or even quarterly – numbers.
If they don’t make their numbers, then they don’t get to go to Bora Bora on vacation.
But unlike the hedge-fund managers, you don’t have to worry about justifying your paycheck. If you’re like me, you want to keep your money safe first. Then you want to see it grow at a decent rate.
That means cash has an important place in your portfolio…
You might not know this, but at any given time, cash has a decent chance at beating stocks.
Going all the way back to 1928, cash returns (as measured by the returns on short-term Treasury bills) beat stock returns nearly a third of the time. Take a look…
In other words, if you forget the stock market entirely and sit in cash, you’ve got a nearly 1-in-3 chance of doing better than the white-knuckled stock investor riding the latest momentum play.
Why invest at all, then? Well, a 1-in-3 chance isn’t enough to grow your wealth. Stocks win most of the time. And of course, when stocks win, they provide bigger returns than cash.
So over the long haul, you want your money in stocks. The question is how much…
Let’s build a hypothetical here. You want to invest $1 million between stocks and cash over the next five years. You want to decide between fully investing in stocks or putting 20% into cash. But you don’t know what the market will do in the next five years.
Now, a professional may look at this in terms of percentage returns, such as, “If the market returns 10%, I’ll only return 8%.” But for an individual, it’s much more important to think of how much money you’ll actually have.
Below, I’ve laid out three scenarios – the market returns 10% a year, returns 2% a year, or undergoes a 30% crash. (Remember, we don’t know which will happen.) In each case, our cash account returns 0.5% a year… And we must consider investing entirely in stocks or putting 20% in cash and 80% in stocks.
Here’s how each outcome looks over a five-year period…
Now, this isn’t a case where the math points you directly to the right answer… This is a personal matter. But if you’re saving for retirement and over the next five years the market returns 61%, should you really care that much about the difference between $1.6 million and $1.49 million?
It’s real money, sure. But you don’t have to kick yourself about missing those gains.
If the market stays quiet and returns 10% in five years, it’s roughly the same. You give up about $20,000 in potential profits.
However, if the market crashes, we’d love to have that extra $61,000. That could be a year or two of retirement for many folks, depending on their lifestyle. What’s more, our cash return of 0.5% is there to help us out. So in this outcome, while the market crashes, we’d be sitting on about $200,000 worth of totally safe, never-going-anywhere, always-going-to-have-it cash.
That peace of mind is well worth missing a few percentage points if the market rises. Plus, you could invest some of that cash near the market bottom rather than the market top to amplify your returns in the eventual recovery.
Most people know that having some cash is important. But exactly how much to hold is the tougher question…
In January’s issue of Retirement Millionaire, I gave my subscribers the ideal asset allocation… how much a portfolio should be spread across blue-chip stocks, cash, government bonds, gold and other commodities, corporate bonds, international stocks, and even speculative investments.
While I won’t give the full allocated portfolio away, I will tell you that the second-largest holding in this conservative hypothetical portfolio was cash. Specifically, 25% of the portfolio was designated to cash.
As always, by cash I mean all the money you have in savings, checking accounts, certificates of deposit (“CDs”), and short-term U.S. Treasury bills. Any investment with one year to maturity or less can be considered cash.
I like to say that cash is king. It will never let you down.
Make sure your portfolio is properly allocated today… and make sure you’re holding enough dry powder.
Here’s to our health, wealth, and a great retirement,
Dr. David Eifrig
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Source: Daily Wealth