When investing, we’re mostly concerned with the two major asset classes: stocks and property. Both offer inflation-beating capital gains over time and property offers the added benefit of attractive yields. But there is another asset class investors generally ignore – cash.
I know, I know, cash is boring – mind-numbingly boring. But we should give it a chance as cash has its uses. One of them is that it has zero volatility. Markets go up, markets go down, but cash steadily increases at the prevailing interest rate. This is important for defensive portfolios. But even for a more aggressive portfolio cash has a place because we can spend it when markets offer opportunities.
Why should you be invested in cash?
But first, let’s discuss the key use for cash. If you are in retirement and using your investment portfolio to cover part or all of your living expenses, you absolutely should have some cash on hand. The reason is simple: if markets are under pressure, you do not want to have to be selling stocks at low valuations.
In short, you would be a forced seller and may be selling at really depressed prices. These prices may well recover in a few months or years, but you don’t have the luxury of time – so you sell.
Now if you had some cash on hand, you wouldn’t be forced to sell and could use the cash for living while you waited for the market to recover. Then once things are back to normal, you could top up the cash balance by selling some of the stocks at the improved prices, or even just wait for dividends to roll in.
This cash holding could simply be kept as cash in a bank account. Alternatively you could hold one of the foreign currency exchange-traded notes (ETNs) from Absa, although you then take the risk of being exposed to an unfavourable exchange rate. Another option is the Absa NewFunds TRACI 3-month (NFTRCI) exchange-traded fund (ETF), which literally just tracks the money-market rate, offering a steady daily increase.
How much of your portfolio should be cash?
The question of how much you should keep in cash is harder to answer. Likely about a quarter to a third of your portfolio should be held in cash, or in one of the ETFs.
For those of us not in retirement, I still think some cash is a good idea. Typically, I keep about 3% to 5% of my portfolio in cash. It’s not a lot, but it does allow me to swoop in if an opportunity presents itself.
If, for example, one of my most loved shares is suddenly under pressure and offering great value, then I can use some of the free cash to pick up some stocks on the cheap without having to sell anything else.
My cash pile is also of course consistently growing via two sources. The first is dividends and the second is inflows from my salary every month. My current portfolio focus is not on dividends, but pretty much all the stocks I own pay dividends, some of which are fairly substantial. So the cash does keep on growing and I keep on spending it, but I always keep a buffer.
To sum up
Sure, cash is boring, but it has its purposes – either for living or for taking advantage of opportunities when they present themselves. The risk for an aggressive portfolio is not to hold too much cash as its return is modest, tracking inflation at best, and if we have too much it will dent our overall portfolio performance.
One last point – don’t use the strategy of “going into cash” because you fear a market sell-off. It is impossible to time such an event properly and in the end you will be worse off if you try.
This article originally appeared in the 3 November edition of finweek. Buy and download the magazine here.