Photo: Aimee Low. Source: Morguefile
Central banks around the world have pushed interest rates to zero. In Europe and Japan, short rates are negative. 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. A sustained bull market raised the cost of cash. From 1995 to 2000 the 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 the oil bust. 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 during a sustained bull market cash will drag on returns.
Photo: Elizabeth Montague. Source: Morguefile
Cash-management is an essential part of any investment strategy. Investors should plan ahead how much cash they want to hold and when to put it to work. Holding cash is frustrating during a bull run, but stocks don’t always rise. In volatile times, having enough cash available lets you pick some bargains when stocks go on sale.
Douglas R. Tengdin, CFA