The Importance of the Often Overlooked Cash Equivalent Asset Class
Building an investment portfolio that is meant to withstand the tests of time and market fluctuations is not an easy task for most do-it-yourself investors.
There are many reasons for this, least of which is that most investors are not full-time chartered financial analysts, financial planners or private bankers.
But possibly one of the most often overlooked realities is that most individual investors fail to give sufficient weight and substance to the less lucrative parts of their portfolios.
Possibly the least lucrative asset class is the cash and cash equivalents class.
Luckily, this normally represents a much smaller portion of one's investment portfolio, but again it is often dismissed as unnecessary.
It is easy to understand why: cash pays very little, if any, interest and has absolutely no opportunity for long-term growth.
In fact, financial professionals argue that holding investments in cash will actually deteriorate your purchasing power if the holding period is of any significance or duration (to illustrate, consider that cash pays no interest yet inflation, or the cost of goods that we buy, continues to increase every year...
$1 today might only buy you $0.
25 worth of the same goods in ten years from now).
However, there is a tremendous opportunity when it comes to cash.
The problem is that it is not an immediate opportunity and, often, that potential may not even be imaginable at the time.
And while there is little interest or gains ever seen in the cash asset class, this asset class typically does not depreciate in value either.
Based on the above, two key reasons why cash is important come to the surface: 1.
Cash is necessary in order to take advantage of key opportunities when it comes to other aspects of your investment portfolio.
Warren Buffett, for example, held as much as $90 billion in cash during the last recession so that he could invest in and purchase companies that he considered cheap.
This accumulation of cash will happen during periods where gains on other securities warrant being taken, or new inflows of cash come into the portfolio.
By capitalizing gains, investors are reducing risk particularly as markets heat up, and by keeping those gains in cash, investors can enjoy those gains without risk of seeing them eaten up by market corrections.
Their cash balance, then, can be used to buy low rather than reinvest at the wrong time and watch those gains disappear.
2.
In line with the above, cash will not drop in value (although currency fluctuations and inflation can, indeed, impact purchasing power).
What will fluctuate is the price on all other securities.
$100 today might only buy 2 shares of one company.
But if that security's price corrects by 50%, then $100 buys 4 shares, or greater ownership and greater opportunity to enjoy gains in the long-term.
Investors should always hold 5% or more of their portfolio in cash.
But as gains accumulate and investors start to capitalize on those gains, increasing the cash portion to even 50% or more is not uncommon, particularly after periods of extended market growth and potential economic slow down.
By keeping funds in cash, investors are better positioned to take advantage of true opportunities when the economy does slow down.
There are many reasons for this, least of which is that most investors are not full-time chartered financial analysts, financial planners or private bankers.
But possibly one of the most often overlooked realities is that most individual investors fail to give sufficient weight and substance to the less lucrative parts of their portfolios.
Possibly the least lucrative asset class is the cash and cash equivalents class.
Luckily, this normally represents a much smaller portion of one's investment portfolio, but again it is often dismissed as unnecessary.
It is easy to understand why: cash pays very little, if any, interest and has absolutely no opportunity for long-term growth.
In fact, financial professionals argue that holding investments in cash will actually deteriorate your purchasing power if the holding period is of any significance or duration (to illustrate, consider that cash pays no interest yet inflation, or the cost of goods that we buy, continues to increase every year...
$1 today might only buy you $0.
25 worth of the same goods in ten years from now).
However, there is a tremendous opportunity when it comes to cash.
The problem is that it is not an immediate opportunity and, often, that potential may not even be imaginable at the time.
And while there is little interest or gains ever seen in the cash asset class, this asset class typically does not depreciate in value either.
Based on the above, two key reasons why cash is important come to the surface: 1.
Cash is necessary in order to take advantage of key opportunities when it comes to other aspects of your investment portfolio.
Warren Buffett, for example, held as much as $90 billion in cash during the last recession so that he could invest in and purchase companies that he considered cheap.
This accumulation of cash will happen during periods where gains on other securities warrant being taken, or new inflows of cash come into the portfolio.
By capitalizing gains, investors are reducing risk particularly as markets heat up, and by keeping those gains in cash, investors can enjoy those gains without risk of seeing them eaten up by market corrections.
Their cash balance, then, can be used to buy low rather than reinvest at the wrong time and watch those gains disappear.
2.
In line with the above, cash will not drop in value (although currency fluctuations and inflation can, indeed, impact purchasing power).
What will fluctuate is the price on all other securities.
$100 today might only buy 2 shares of one company.
But if that security's price corrects by 50%, then $100 buys 4 shares, or greater ownership and greater opportunity to enjoy gains in the long-term.
Investors should always hold 5% or more of their portfolio in cash.
But as gains accumulate and investors start to capitalize on those gains, increasing the cash portion to even 50% or more is not uncommon, particularly after periods of extended market growth and potential economic slow down.
By keeping funds in cash, investors are better positioned to take advantage of true opportunities when the economy does slow down.