If you are reading this article, you are probably already managing your portfolio. Everyone talks about the balance of stocks and bonds but cash allocation is often times a byproduct of other allocations and not an actual decision being made.
The conventional wisdom is that you don't want to hold too much cash, it's actually a great problem to have but can lead to stress or making hasty decisions. There are opportunity costs of holding cash so where should your target be?
I'd like to do a crowdsourced interview with the community here to see if it's possible to come to a few meaningful conclusions.
What's great about this community is that there are many investor styles present here: dividend growth, total return, options, ETFs, real estate, precious metals, the list goes on and on! There is also an enormous range of both age and investing expertise. I have no doubt we'll get a wide range of answers, so this is exciting to crowdsource our thoughts to try to help every investor take something away from this discussion.
Please note for these examples, we are going to be talking about cash in an investment account not day-to-day spending or savings cash.
- What type of investor would you say you are?
- How many years of investing experience?
- Do you have a cash allocation target? If so, are you at it?
- Do you base your allocation on your personal cost or total portfolio value?
- Why are you holding it?
- Is there a time limit for how long you would hold higher amounts of cash?
- Do you have a different proxy than just holding cash?
- Has this current environment changed your allocation?
- What would you tell your younger self knowing what you know now?
My intention here is to think about tough questions that I am asking myself and hopefully produce a meaningful, thoughtful and truthful answer. If you lie, you are only lying to yourself.
I would like to clarify a few points before jumping into my answers.
Do you base your allocation on your personal cost or total portfolio value?
Frequently, I'll see or hear someone say they are at 10% cash and wonder how that figure is calculated. Consider the following:
- $100,000 total portfolio value
- $90,000 in equities and bonds
- $10,000 in cash
If the equities portion of the account doubles to $180,000, the math alone makes the cash a little over 5% of the total account value at that point in time. Would this person be raising additional cash to keep the 10% ($20,000) needed in this example?
Conversely, if the stock portion drops 50% to $45,000, the cash portion now makes up over 20% of the portfolio value.
If you believe in buying the dip, the above example may actually play out better in the long term by basing it on the portfolio value itself. If your stocks take off and double, they may be overvalued - maybe not - and you may consider saving more cash for when prices return to normal.
Additionally, if the market falls that is the time to invest more and maintaining your cash position in a falling market will force you to buy some stocks when they are possibly on sale.
Or is your target based on what you personally put in and disregard what the current value of the equities are?
Why are you holding it?
Seriously, why are you holding cash? The return on cash, especially today is essentially negative after counting inflation. Are you trying to time the market thinking something big is coming? Is it a valuation concern? Are you waiting like Warren Buffett with the proverbial "elephant gun"?
There are opportunity costs from holding excess cash, even holding a dividend ETF can produce about 3% return.
I'll preface this by saying that I went through a couple of iterations of writing down questions, then pondering myself what I would say. So with that said, I'll start.
- What type of investor would you say you are? I would identify as a dividend growth investor generally though I think there is a lot of crossover with a "total return" investor.
- How many years of investing experience? About 10 years though my first experience was buying a mutual fund through ING Direct back in high school.
- Do you have a cash allocation target? If so, are you at it? I think my preferred target would be 5-10%. No, I am still above my target because of my transition over the past year to completely managing my 401(k).
- Do you base your allocation on your personal cost or total portfolio value? I think writing my thoughts down above changed my answer. I would have previously said based on my own cost but I think it may make more sense on total value. If the market drops 50%. that's the time to put more in.
- Why are you holding it? Since I've been fully self directing for about a year, it has taken longer than I initially expected to get to my target allocation. Looking back even 6 months, there were still a lot of undervalued quality companies. I'm having a hard time these days finding much. Part of me is always cautious thinking the market could see a large pullback after having a huge run for many years.
- Is there a time limit for how long you would hold higher amounts of cash? No, so like I mentioned in the other question, I am having a hard time finding companies at reasonable valuations. If the market as a whole continued to push forward to new highs, I won't pile in thinking I have missed the boat.
- Do you have a different proxy than just holding cash? I don't but I am open to ideas! Maybe a low beta dividend ETF might fit the bill, something to generate a little return that ideally won't change nominal value much.
- Has this current environment changed your allocation? I'll say yes it has, I don't generally want to try to be a market timer (thus, all dividends are reinvested), but I am aware of valuations. Even if I truly thought we are due for a large pullback, it may take years to play out, and in the mean time, the cash could have been earning something.
- What would you tell your younger self knowing what you know now? I would tell myself that you can be right for the wrong reasons and wrong for the right reasons. It has not been a secret that stock multiples have expanded in our zero interest rate environment. The key to long-term success is to stay invested and to always keep investing. A pricey market does not always imply a bubble.
It should be evident at this point that the actual answer will vary based on one's own circumstances. That said, I hope you can answer these questions in earnest, especially from the more senior members of this community.
I think there is going to be information everyone can take away from the responses, especially younger investors and I may highlight some of the sage wisdom in a future article.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.