Yahoo Finance How Much Cash Is Too Much Cash for Your Portfolio?
Cash is king. Cash is trash. Nowhere is cash more controversial than in investing, where having "too much" of it is considered a risk. And how much is "too much," anyway?
The debate reignited earlier this month when Charles Schwab launched Intelligent Portfolios, an algorithm-based platform that builds and rebalances portfolios automatically, similar to the asset-management services of robo-advisors. Charles Schwab's treatment of cash in the platform raised eyebrows immediately, attracting criticism of its allocation to cash, anywhere from 6 percent to 30 percent based on an investor's risk profile.
"There's no right or wrong answer to how much cash an investor should hold as an investment, it is a strategic decision," Charles Schwab responded. "It's easy to question cash in the sixth year of a bull market and when the Federal Reserve is artificially suppressing interest rates, but we don't invest based on the last six years. We invest based on what we expect the future may hold. Bull markets end and interest rates rise. When they do, a little cash will feel pretty good."
So, how much should one hold in their brokerage accounts? On this, both sides seem to agree: There isn't one answer that fits all circumstances. Determining whether you, as an investor, have too much, given your tolerance for risk, investment goals and horizon, is an important part of your overall investment strategy. The three steps below may help you arrive at an answer that works for you.
1. Distinguish between household cash and portfolio cash. First things first: Don't mix up (or lump together) portfolio cash and the cash you hold in bank accounts as an emergency fund. "There's a huge difference between someone who invests their portfolio 50 percent in cash, versus someone who has a $50,000 401(k) and a $50,000 savings account," says Michael Kitces, partner and director of planning research at Columbia, Maryland-based Pinnacle Advisory Group. Although that second investor may have 50 percent of their assets in cash, their 401(k) is fully invested, he explains.
Although there isn't a lot of benefit to having a large cash holding in your portfolio, Kitces says there are a lot of good reasons to have a "relatively sizable household cash holding." The rule of thumb is to have at least six months of living expenses saved up in an emergency fund, which could be a large percentage of net worth for investors in the accumulation stage.
2. What percentage of your portfolio holdings is cash? If you completed the exercise in step one and determined you have enough emergency savings, it's time to move onto step two. Determine what proportion of your investable assets is in cash. In industry speak, having too much cash in a brokerage account is called "cash drag," simply because that cash doesn't produce any yield.
A quick look at the asset allocation of your brokerage accounts will give you the answer. If you have multiple brokerage accounts with different brokerages, you'll need to do some math or sync your accounts with a portfolio tracking app, which will do the math for you.
As of March 2015, 27 percent, of investors who track their portfolios with SigFig hold 10 percent or more of their portfolios in cash. Is 10 percent too high? What percentage is ideal? Again, no single answer fits everyone's circumstances, but moving on to step three may help you figure it out.
3. The million-dollar question: Why? You'll have to dig deep into your emotions with this one. Why is that money in cash? Did you panic and sell a certain stock or fund during the market crash and leave that money sitting on the sidelines? Are you afraid the markets have peaked? Do you have a compelling reason for keeping a portion of your assets, such as being ready to jump into the next investment opportunity? When the answer involves an investor's emotions, chances are that the cash allocation may be too large.
"I look at cash in a portfolio as a measure of an investor's emotional level," says Barry L. Ritholtz, chairman and chief investment officer of Ritholtz Wealth Management. "It's a sign of fear and an indication of emotional concern."
Granted, Ritholtz doesn't often meet with investors concerned that their 5 percent cash holding is too large. Usually, it's people who have 10 percent, 20 percent or 30 percent of their portfolios in cash, he says. "If you want less money exposed to stocks, then set up six months worth of expenses in a savings account and occasionally put money in there to keep up with inflation," he says. Keeping cash because you're afraid of the future or are trying to time the market, however, is a mistake. "History tells us that the average investor is bad at timing the market, and professionals aren't better," Ritholtz says.
One solution to cash drag is to divide that extra cash into six or 12 equal parts and deploy the money monthly, Ritholtz says. "That's just one way to overcome those emotions. And that's really what this is about. Keep your emotions in check," he says.
Aleksandra Todorova is the editorial director at SigFig , a portfolio tracking and management company in San Francisco, California. Nearly a million people use SigFig to track, improve and manage over $350 billion in investments.
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