Should You Hold Cash In Your Portfolio?

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Now for today’s piece:

Should You Hold Cash In Your Portfolio?

Highlights

The Role Of Cash In A Portfolio

Cash on its own has historically been a terrible investment.

It has lost value over time and pales in comparison to other assets like stocks, treasury bills, and bonds.

But cash as part of a greater asset allocation strategy can prove to be beneficial for a few reasons.

Cash is held to:

• Provide Liquidity

• Reduce Volatility

• Offer Downside Protection

We will explore the benefits of cash in today’s piece.

Benefits Of Including Cash In Your Portfolio

Provides Liquidity And Flexibility

One benefit of holding cash in your portfolio is to have liquidity and flexibility.

By keeping some cash on hand, you have the ability as an investor to:

• Take advantage of market drawdowns

• Buy items you want without having to finance them

• Have a safety cushion for you and your family in case of emergencies

Reduces Volatility And Risk

Another benefit of holding cash is that it reduces volatility and risk.

Let’s say you are 100% invested in equities. In this example, your investment portfolio’s performance would be completely tied to the fluctuations of the market.

Now let’s say the market has a 20% drawdown, as it often does once every 7 years. Your portfolio’s worth has now been reduced by that same 20%. This may be something you are comfortable with and that’s okay so long as you know the risks.

But, if you would rather be able to cushion the downsides and reduce risk, cash can help.

Let’s say instead you were holding a portfolio that was 90% equities and 10% cash. In the event of the same 20% decline, your portfolio would have only declined 18% this time – thanks to the cushion cash provides.

Yes, 2% saved may not seem like a lot, but if your portfolio is worth $1,000,000 you would be saving $20,000.

Nothing to sneeze at.

The amount of cash in your portfolio can also be adjusted to meet your individual needs as an investor.

Offers Protection During Market Downturns

In the last example, we saw that cash will help protect your portfolio. Cash can also protect you as a person.

Unfortunately, market drawdowns often precede recessions. These recessions often bring layoffs which we’re seeing take place across the tech industry right now.

Layoffs can happen to anyone and they’re just one of the many events that could affect the cash you have on hand.

Without sufficient cash on hand, you may have to sell investments to cover things like unexpected layoffs.

The selling of these investments will likely coincide with a market downturn, meaning you may have to sell at a loss or a less than optimal price.

We as investors would like to see our investments grow as long as they can.

And keeping cash on hand to avoid having to sell investments during emergencies will help us do that.

Provides You The Opportunity To Sell Cash-Secured Puts

The last reason to hold cash on hand is to be able to sell cash-secured puts (CSPs).

CSPs are a conservative options strategy that allows you to generate income by selling contracts of 100 shares of a particular stock at an agreed-upon price.

By selling a CSP, you are obligated to purchase 100 shares at that agreed-upon price, so make sure you want to own the stock you’re selling CSPs for.

I wrote a complete in-depth guide on Cash-Secured Puts that you can read for free here.

But to sum up cash as it relates to CSPs, the cash you have on hand will help you generate more cash if you’re willing to sell options.

Strategies For Holding Cash In Your Portfolio

Ultimately, how much cash you want to keep on hand is entirely up to you.

The cash I want to hold and the cash you want to hold will vary based on our risk tolerances.

Recently I came across a very interesting thread written by @BrianFeroldi about an investor named Tom Engle.

Engle has an investment strategy in which he was able to work for 9 years, quit, and live off of the cash in his portfolio.

I encourage you to read the thread but basically, Engle’s cash strategy is this:

• He comes up with a protected value for his portfolio on which all cash decisions are based (ex. $100,000)

• He decides if the market is overvalued, undervalued, or fairly valued

• If the market is fairly valued, Engle will keep ~12% cash on hand ($12,000)

• If the market becomes overvalued, Engle will trim his holdings until he reaches a maximum of 20% cash ($20,000)

• If the market falls into undervalued territory, Engle will invest up to 99% of his cash into companies trading at a discount

• As the market rebounds, his bargain buys will pay off allowing him to create a new protected value number ($200,000) and pull 12% out as cash ($24,000)

• This trimming and adding strategy has allowed Engle to grow his cash alongside his portfolio

• In normal market fluctuations, Engle keeps between 5-15% in cash, a strategy that I’d like to adopt

Adopting Engle’s cash management strategy would be a shift for me.

Up until this point, I believed that any cash that wasn’t immediately invested was cash that I could be generating dividend income from. In turn, I’d invest every single dollar I had as soon as I could.

I now see the value of stacking some cash, reducing volatility, and having extra buying power ready to take advantage of market drawdowns.

Final Thoughts

Holding cash was not something I did in my investing.

I’ve moved on from the belief that I should invest every dollar the second I get it. I was constantly running out of buying power and waiting for payday, so I decided to change my strategy.

Instead, I now aim to keep 5-15% cash on hand depending on overall market valuation. This will help me take advantage of major market corrections, reduce my portfolio’s volatility, and provide a financial cushion for any emergencies.

Ultimately, every investor has different risk tolerances and needs. How much cash I’m comfortable holding will be different from how you feel. I hope this article helped spark a desire to examine your cash position and helps simplify your investing journey.

Happy Dividend Investing!

Sincerely,

Dr. “Cash On Hand” Dividend

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