Many investors think of cash as dead weight in their portfolio. Especially in our current low-yield environment, it sits on the sidelines in money market funds where it is exposed to inflation. A recent Wall Street Journal column by Morgan Housel, however, makes the case that holding a significant cash position can have strategic benefits that can boost performance.
We generally try to hold at least 3-5% in cash in a portfolio and sometimes have more depending on our view of the market and the client’s situation.
Having a cash stockpile allows an adviser to take advantage of a pullback in the market or any other opportunity that comes up. Housel cites several managers that have strong performance despite a large cash position:
“I always view holding cash as an opportunity, not as a cost,” [Arnold Van Den Berg, chairman and co-chief investment officer of Austin, Texas-based Century Management] says. “The view people have these days is they don’t want to be in cash because they’re going to lose money, when they should look at it another way and see it as an opportunity to buy cheaper when the market comes down.”
Michael Kitces, director of research at Pinnacle Advisory Group in Columbia, Md., says this strategy requires purposefully losing a small amount of money to inflation over a period in exchange for the opportunity to offset it with a larger profit down the road. Some investors might not have the stomach to endure the pain this can cause while waiting for opportunity to strike, he says. But for patient investors, the gains can be well worth it.
While it is unwise to time the market by jumping entirely in and out, holding onto cash for a future opportunity allows you to make smaller adjustments at the margins depending on what’s going on in the market. Housel quotes Warren Buffet who said, “Cash combined with courage in a crisis is priceless.”
Another benefit of holding onto some cash is that it prevents forced selling when a client needs an unexpected withdrawal. Selling at an inopportune time can hurt performance and have negative tax consequences.
Of course it’s possible to take this strategy too far. We rarely hold onto more than 10% except perhaps in special situations.