Cash serves a valuable purpose in many investment portfolios, but when the stock market plunges, many investors turn to cash in a knee-jerk reaction to avoid losses. However, depending on the reason, shifting all your investments from stocks to cash can turn out to be a big mistake. Even during a bear market, holding a cash-rich portfolio can cause you to lose more money than you think. Instead, consider cash uses and allocate only a portion of your funds to this asset class.
A financial advisor could help you rebalance your portfolio and select investments that match your financial goals. Find a qualified advisor today.
Three reasons why silver could be a losing proposition
In a situation where high inflation and rising interest rates are the new normal, the value of your dollar is falling every day. This loss of purchasing power can add up significantly over time, and by not investing in defensive stocks or high yield bonds, investors lose the opportunity to earn interest.
According to investment firm Charles Schwab, a standard inflation rate of 3% would reduce real purchasing power by $100,000 by 14% over five years. Over 10 years, this purchasing power would drop by 26% and over 20 years, $100,000 held in cash would only equal the power of $55,368. In this case, a portfolio consisting entirely of cash always loses value over time, even though the dollar amount appears to remain constant.
Today’s low interest rates for short-term investments further reduce an investor’s earning potential. If an investor moves all funds into a regular savings account or money market fund, opting for cash and short-term bonds, the higher bond yields will reduce the value of these less volatile investments. Even then, short-term bonds often yield more than just cash.
Due to market turmoil, some investors may decide that withdrawing funds from riskier growth assets and putting them entirely in cash can protect their money. But in doing so, these investors are giving up potential opportunities for capital appreciation.
How much money should you hold then?
Even in his most conservative model portfolio, Charles Schwab only allocates 30% to cash investments. The rest goes to 50% in fixed income securities and 20% still in equities.
In the World Wealth Report 2021, Capgemini reports that the world’s high net worth individuals have allocated between 21 and 28% of their assets to cash during the crisis years over the past two decades. 20-30% was allocated to fixed income securities, and a further 20-30% was held in equities. If or when the economy warms up again, these cash reserves will help investors buy cheap homes, stocks and other assets.
Famed billionaire investor Warren Buffett also believes cash is vital for emergencies, and his company Berkshire Hathaway holds $144 billion in cash or cash equivalents even now. In his annual letter to shareholders, Buffett noted that he “still keeps 80% of his assets in stocks” and so far he and his partner have found no “exciting” offers to buy stock. listed on the stock exchange.
He says that while they “have endured similar cash-heavy positions from time to time in the past, those positions… are never permanent.”
Indeed, Schwab’s research indicates that the average bear market lasts 15 months with a cumulative loss of 38.4%. On the other hand, the average bull run lasts 6 years, offering returns of over 200%. Since bear market rallies are often anticipated, perhaps ensuring you have enough cash to take advantage of these opportunities might be the best bet after all.
Cash reserves are an important part of an investor’s portfolio, but turning to holding all cash during a market downturn can be a big mistake. Inflation erodes the purchasing power value of money over time, and holding funds in cash often results in the loss of opportunities that could earn more over time. Instead, retail investors could follow the lead of many other high net worth individuals and maintain a healthy cash reserve while keeping some of their funds allocated to stocks. On average, 20-30% of funds allocated to cash can allow investors to protect their investments against major market declines and have a cushion to buy when the economy recovers in the future.
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Is the position Cash Trash? This Should Be Your Cash Allocation in a Bear Market appeared first on the SmartAsset blog.