How Cash Works in Your Portfolio
Cash is more than just the dollar bills in your pocket—it can be a powerful part of your investment portfolio. However, the cash allocation in your portfolio is usually a bit different than the cash in your bank account. Let’s look at what cash means from an investment context and how it can fit into your overall portfolio.
What is Cash?
In daily life, the word “cash” generally refers to the physical bills you withdraw from an ATM. More broadly, it’s the money sitting in your bank accounts right now. While these bank accounts often pay some kind of interest, the rate is usually lower than 0.5% per year.
The usual low yield on bank accounts means they may not be the best place to keep cash in your portfolio. That’s where cash equivalents come in.
When we talk about cash in the context of a portfolio or investing, we’re often speaking about cash equivalents. These are highly liquid products, filled with short-term investments, designed to pay a higher yield than basic savings accounts. The most-commonly used cash equivalent is a money market fund. These funds can be structured as mutual funds (regulated as securities) or savings accounts (regulated as a bank product).
The individual holdings within these funds range from certificates of deposit (CD) to Treasury Bills. The investments within the fund influence both risk level and rate of return. For instance, a money market fund that invests in riskier short-term assets and is regulated as a security may pay a higher yield than a money market savings account backed by the Federal Deposit Insurance Corporation (FDIC).
How Cash Works in a Portfolio
Cash in a portfolio can help create opportunity to buy new investments as they arise. However, whether you should have a cash allocation, and the size of that allocation, depends on both your personal circumstances, as well as the overall market and the economy.
Cash can also help diversify your portfolio. However, cash is subject to inflation risk; if the yield on cash equivalents is lower than inflation, the cash in your portfolio loses purchasing power.
There are times when cash equivalents become more attractive. When the yield curve inverts (as it did in 2022), short-term treasuries and other cash equivalents start to pay higher rates, which can make money market funds more appealing, depending on your objectives.
However, just because cash equivalents are yielding more doesn’t necessarily mean you should rethink the role of cash in your portfolio. Plus, if a cash allocation makes sense for your circumstances, it’s important to build the allocation strategically. There’s a difference between selling investments to hold cash and keeping any new additions to your account in cash. Both should be done strategically and with the rest of your portfolio in mind.
Having a cash position coupled with a disciplined investment strategy can change your perspective on market volatility and troublesome economic indicators. Why? Because that cash allocation puts you in a position to take advantage of a downturn by picking up stocks at a “bargain” price without locking in losses.
The Role Cash Plays in Your Financial Plan
Everyone’s financial plan looks different since it’s based on your current needs and future goals. How we think about cash and cash equivalents in your portfolio may depend on a variety of factors, including:
- Your current emergency savings;
- The going rate of short-term cash equivalent products; and
- Upcoming expenses that require liquidity (like homebuying, starting a business, or paying for college).
Once we have a good sense of your personal finances, we can help clients spot opportunities to use cash and cash equivalent products to take advantage of changing interest rates.
This is more important than ever when inflation is high since higher yields on cash can help protect your purchasing power and mitigate inflation risk. If you have any questions about your current positioning or want to learn more about how we can address your short- and long-term financial goals, schedule a call to discuss.