Holding a percentage of cash in your trading portfolio is the unsung hero that many traders do not utilise. When trading, many investors do not consider having a small portion allocated to cash. I am not talking about investing in money-related items, more so having spare dollars, ready to utilise when ready.
I do not see money as an investment tool – by itself, it is not going to grow as stocks will. It would take decades for the cash sitting in your account to show any potential growth. Also, the exchange rates need to be in your favour. Here I am
Cash lets you strike when the opportunity is right.
We have all been in the situation where we like stock X and there is a great entry price… but we have no spare equity. If you did not have the spare money, you would need to sell some stocks to free up some capital. When you sell that stock, you also risk the timeframe from settling that sell, to when the cash is within your portfolio. This could mean missing out on your opportunity. Having cash lets you seize this opportunity, particularly in turbulent times.
This was evident during the downfall of the markets and subsequent bounce in March 2020. If you had the spare cash in the second half of March and invested, you would have seen some great returns over the next few months. If you did not have any cash, you could miss out on some great bargains. Even if you are fully allocated in stocks and accept that risk of being fully allocated. Choosing to hold some cashback gives you the chance to capitalize on unexpected market declines quickly and effectively.
Having cash leaves your other stocks alone
The second part of having it freely available means that if things do happen in the real world and you require some funds (i.e. an emergency) you could withdraw these funds without having to impact your current portfolio. This also aligns to have to liquidate stocks to buy more stocks, potentially minimising future profits from that stock.
Whilst it is a long way off for most of us, having cash becomes more crucial as you get closer to retirement age. Imagine you are not far out from retirement, you have a great portfolio with awesome stocks at the start of 2020, then the pandemic came. Many traders could not see the bounce back in March/April and would have panic sold to minimise losses. This is going to have a deep impact on your portfolio. Now imagine, if you knew that you were getting closer to retirement and you slowly started converting some of your growth stocks to cash and held on to some of your strong dividend stocks. When the market turned, your portfolio would still be impacted but you will still get those dividends, plus have cash on hand to continue living your life.
The main point here is that you never know when you will need cash. You could have been laid off your job due to the pandemic and have not found a job since. That is a solid few months of no income for most people. If you had a smallholding of cash, you could utilise it within touching your current portfolio holdings. Holding on to cash ensures that you will have it when you need it and not make brash decisions when there is turmoil in the air.
Cash reduces drawdown
Having an allocation of cash helps minimise the drawdown of your portfolio. If you were 100% invested in stocks, any market volatility will impact 100% of your portfolio. If you had only 75% invested, then 25% should not be impacted. I know what you are thinking – but being fully invested ensures that I will get all the maximum gains. Well, yes, but you will also get the maximum losses. I am far more comfortable with most of my portfolio being in stocks with an allocation for cash, to help reduce the risk and minimise losses. You never know when the market will crash and burn, or even simmer over a long time. Being aware of the market and not ‘putting all your eggs in one basket’ is a sure-fire way of ensuring portfolio health and longevity.
Top Investors are doing it and know better than you
It is hard to go a few days without someone blurting Warren Buffet has a $120 billion war chase. Yes, he does, he has a few more pennies than I do though.
Privately, wealthy people like to hoard cash, as well. A 2019 Capgemini World Wealth report released found that people with at least $1 million in investable assets kept nearly 28% of their portfolio in cash (https://worldwealthreport.com/wp-content/uploads/sites/7/2019/07/World-Wealth-Report-2019.pdf).3 If (or when) the economy enters another recession, those cash reserves will allow these wealthy investors to buy cheap homes, stocks, and other assets.
These cash holdings allow for new investing opportunities. Buy stocks, houses, start-ups etc when they are cheap. Adding towards their passive income streams and continuing to let the grow their wealth. If they did not have this cash available, could they still achieve the same results?
I heard a great quote from Warren Buffett about cash – cash is like oxygen—everyone needs it and takes it for granted when it is abundant, but in an emergency, it is the only thing that matters.
Conclusion
So, from the information above, you can see why I am in favour of holding some cash in my portfolio. There will be great opportunities moving forward to ensure a reduction in portfolio drawdown, grab bargain entry prices when possible and to safeguard any emergency funding required.
What about you? Do you hold cash in your portfolio?