Saturday, August 31, 2013

Should you hold cash in your portfolio?

Here are a few insights.

More than one-quarter of Americans prefer cash as an investment.
Preference for cash was most evident among individuals with lower earnings and less education.

High-income individuals prefer stocks and real estate.

When it comes to education, 32 percent of individuals with a high school degree or less choose cash, but just 19 percent with a university degree.

Women prefer cash to men and men prefer stocks more than women do.
Cash is NOT an investment. And, there is a real cost to sitting on cash. Thanks to taxes and inflation, the returns are negative over the long run. Which is completely self defeating since one's entire retirement kitty can be jeopardized with this mentality.

How will one build up a huge nest egg for retirement or fund a child's education if one's investments are not beating inflation and delivering returns over and above the tax rate? Ironical, since people hold cash to feel safe and that is what they are not when they do so.

There are legitimate reasons to hold cash, but it is the duration that matters. If you plan to sit on cash for years, that is where the problem is. If it is just a few months, you are completely justified. Do note, when we refer to cash we are talking of your money in a savings account, and liquid and ultra short-term funds.

Here are some instances where cash fits the bill.

You have suddenly come into some money and not sure where or how to deploy it. This could be due to a bonus, inheritance, gift or even a tax refund. Alternatively, you could have exited some investments and are still unsure as to which investments you should channelize your money into.

It could also be that you are strategically holding cash because you were of the opinion that the stocks you owned were completely overvalued and decided to sell them. Again, till you are ready to pick up some other stocks with reasonable valuations, you plan to stay in cash. But this is purely tactical in nature.

For instance, debt fund managers have increased their cash allocations in recent times as they keep an eye out on the central bank's moves and direction of the rupee.

If you have a financial commitment round the corner, such as downpayment for a home or a holiday abroad or a child's tuition fee, then it would be disastrous to put the money in an equity instrument. At such times, cash makes perfect sense.

Some cash should always be kept in an emergency fund. So that if there is a sudden calamity like losing one's job or an illness which requires a fair amount of expense, there are funds to bail you out.

So other than a few genuine instances, cash is not a viable long-term portfolio allocation. If you opt for it, you could well be sacrificing your long-term financial health.


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