Cash: Trash or Treasure?

What good is cash?

Central banks around the world have pushed interest rates to zero. In Europe, short rates are negative. Most bank deposits and money market funds pay almost nothing. Why should investors hold cash?

Cash used to be thought of as a weapon, or a market sector. Mutual funds held up to 10% of their portfolios in cash. After all, cash allows managers to move quickly when they see opportunities. And when the market falls, cash looks pretty good. It may not earn much, but at least it’s stable.

But that changed in the ‘90s. An ebullient market raised the cost of cash. From 1995 to 2000 the stock market tripled. A 10% allocation to cash cost investors 6% of their portfolios, or 1.5% per year. Consultants told institutional investors, “We don’t pay you to manage cash.”

But then came the dot-com crash, 9/11, the housing boom-and-bust, the Euro crisis, and so on. People with cash could respond to the market’s swings. Cash is an option. When the market is volatile, the value of that option rises. It protects investors in bear markets, and allows them to add to their holdings when the market falls. But in a bull market cash drags on returns.

Cash-management is an essential part of any investment strategy. Investors should plan ahead how much cash to hold and when to put it to work. Holding cash is frustrating during a bull run, but stocks don’t always rise. When they fall, a cash-stash will make you very happy.

Douglas R. Tengdin, CFA
Chief Investment Officer
Phone: 603-224-1350
Leave a comment if you have any questions—I read them all!

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