"Is it time for you to move to cash" was a headline I saw on Reuters.com on Wednesday. Just two days earlier, I had spoken to a member who was considering putting part of his portfolio into a money market fund.
This was likely just a coincidence, but both occurred as the U.S. debt ceiling debate remains unresolved (something that may or may not change by the time you read this) and Europe is dealing with its own problems. Plus, the economy is moving along at a sluggish pace.
Yet, despite the Reuters' headline implication that investors are moving to cash, the data suggest otherwise. Retail money market funds held $919 billion in assets as of July 13, according to the Investment Company Institute (ICI). This is down from $947 billion at the start of the year. Institutional money market funds also hold fewer assets now than they did at the start of the year.
This is not to say that there aren't some investors who have shifted to cash. Cash allocations were at 21.5% in our June Asset Allocation Survey, the highest levels since August 2010. I have also heard from some AAII members who have decided to increase their cash allocations. But there has not been a run to cash. In fact, cash allocations remain below their historical average, according to our survey.
Cash does have an allure when times are uncertain because its reported value is not impacted by the fluctuations of the market. Your purchasing power (what a dollar can buy) will eventually be eroded, and there are risks associated with where cash is stashed, but the account balance of cash isn't impacted by the market's ever-changing mood. I should add an asterisk to that last sentence because there have been discussions about letting a money market fund's reported net asset value float daily. The result would be that a fund's net asset value could drop below a $1 per share on a given day, the so-called "breaking of the buck."
The problem with moving to cash when market conditions are considered to be unfavorable is knowing when to get back out of cash. Selling out of stocks during the summer of 2007 and getting back into stocks in March 2009 would have been a great strategy, but few people actually did that. Thus, while you may limit your downside risk, you also risk losing out on potential gains. One of the most common mistakes that investors make is moving into and getting out of cash too late, locking in big losses and missing out on big gains.
Over short periods, an allocation to cash is not a bad thing, especially if it accounts for a small portion of your portfolio. This is particularly the case if you sold a security or fund and are trying to decide where to reinvest the proceeds. Cash also makes sense if you know you are going to have an upcoming withdrawal from your account, such as a required minimum distribution (RMD) from an IRA.
You also need to look at what you have outside of your brokerage accounts. Financial planners recommend that employed individuals have cash savings equal to several months of expenses. Retirees should also have a certain amount of savings to cover unexpected events and emergencies. If there is a large expense that you expect to incur within the next couple of years, such as a new car, you should keep those funds in cash as well. I bring this up because all of your accounts contribute to your net worth, and anyone with a savings account already has an allocation to cash. Thus, you already have some protection against the market's volatility.
The key to portfolio risk is to find a balance between what allows you to sleep at night and what allows you to achieve your financial goals. If you want to protect your wealth against the eroding effects of inflation, you will need some exposure to stocks. Cash can provide short-term safety, but it won't protect you against the dual threats of inflation and the risk of outliving your money.
This Week's Gratis Tip
Moving into and out of cash is one method of managing your short-term risk exposure, but it does not address a long-term risk facing many investors: what happens to your estate after you pass. An estate plan helps to ensure that the wealth you have worked so hard to accumulate and grow will be properly distributed according to your wishes. Reassessing Your Risk Tolerance? Don't Overlook Estate Planning provides guidance on how to create a plan.
The Week Ahead
More than 150 S&P 500 (NYSEARCA:SPY) members will report second-quarter profits next week. Dow components scheduled to release results include 3M (NYSE:MMM) on Tuesday, Boeing (NYSE:BA) on Wednesday, DuPont (NYSE:DD) and Exxon Mobil (NYSE:XOM) on Thursday and Chevron (NYSE:CVX) and Merck (NYSE:MRK) on Friday.
On the economic calendar, the Conference Board's July consumer confidence survey and June new home sales will be released on Tuesday. Wednesday will feature June durable goods orders and the periodic Beige Book. June pending home sales will be released on Thursday. Friday will feature the first estimate of second-quarter GDP, along with the final July University of Michigan consumer confidence index and the July Chicago PMI.
The Treasury Department will auction $35 billion of two-year notes on Tuesday, $35 billion of five-year notes on Wednesday and $29 billion of seven-year notes on Thursday.