These days, it’s hard to remember why we hold any cash in our portfolios at all. A quick search of money market funds shows results that are abysmal. According to financial website Bankrate, the average interest rate on a money market account is currently 0.08%. At that rate, a $10,000 investment would net you a cool 67 cents after a year. That’s terrible. And that return is even worse when you factor in inflation. With rates so low, holding cash is actually losing purchasing power.
On the flipside, other asset classes have continued to rise. In the subsequent years after the crisis, stocks have continued to rally – with the S&P 500 as represented by the SPDR S&P 500 ETF (SPY) surging more than 400% since its bottom in the Great Recession. Treasury and corporate bonds have followed suit.
And with the Fed pledging to keep rates low for much longer than anticipated, cash and its negative returns just doesn’t make sense in today’s world.
Except that it does.
Holding some investment cash – which should not be confused with an emergency fund – makes sense for investors on a number of reasons.
The biggest benefit for holding cash over other asset classes is liquidity needs. Obviously, if you have the need to spend a portion of your portfolio relatively soon, then having it in an easy-to-sell and non-volatile asset class makes a ton of sense. If you need money to live off of or plan for short-term expenses, then you can’t take on too much risk.
For retirees or investors with unstable employment situations – think freelancers –cash offers a huge buffer when the market experiences a downturn. Nothing is worse than having to sell assets in the bottom. Having a cash buffer is crucial to providing a buoy for investors.
Finally, even younger investors can benefit from having some of their portfolio in cash. Cash can be used for market opportunities. Having some dry powder that’s ready to take advantage of declines is critical to earning better long-term returns. While market timing usually never works, the market does occasionally provide “gifts” for long-term investors.
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