The myth
Cash helps balance out an investment portfolio. It also provides liquidity, giving you easy access to money when you want to take advantage of investment opportunities.
However, cash doesn’t grow in value and even loses some of its purchasing power when prices rise and inflation is high. That’s why some prefer to keep just a small amount of cash in their portfolio.
The reality
When choosing where to allocate your money, one thing you might think about is opportunity cost. This is the potential profit or other benefits you might lose by picking one investment over another – or by not investing at all.
Some might consider keeping cash as a lost or wasted opportunity since it has the potential to grow faster when invested.
However, there are also advantages you might miss out on by not having cash in your portfolio, such as:
- Flexibility
When there’s a new investing opportunity that can be a good addition to your portfolio, it’s much easier to act when you have cash readily on hand. You won’t need to move money around to free up your resources.
- Stability
Cash can act as a buffer in case of unpredictability in the markets. It can help with your efforts to properly diversify against risks and minimize loss.
The relative safety of cash can also be comforting during times when your investments aren’t doing well. Having cash can be good for your financial and emotional well-being as you ride out the ups and downs of investing.
Verdict: It depends.
A cash cushion can be an essential part of your investment strategy, but having a lot of it might drag down the overall returns of your portfolio.
The exact amount of cash you must keep in your portfolio depends on your situation. You can look at popular asset allocation models for guidance.
Some fund managers allocate at least 5% in cash for opportunities, while some keep cash equivalents so they can still earn and get liquidity at the same time.
Whether you want to have cash on standby or invest more of it, remember to keep your short- and long-term needs and goals in mind and account for situations where “Cash is king.”
