The flexibility and stability of cash is hard to beat. Just don’t hold onto too much of it.
Some investors view holding cash as a losing strategy. But under certain conditions, such as periods of rising interest rates or times of stock market turbulence, it tends to do well relative to other asset classes.
As interest rates have risen over the last few years, cash and cash alternatives – including Treasury bills, certificates of deposit, corporate commercial paper and other money market instruments – have gained a bit of luster as a viable alternative to other assets classes such as bonds, as a strategy to hedge against downturns and as a source of liquidity.
Here are four solid reasons why holding onto some cash may be a good idea now and in the future.
To follow legendary investor Warren Buffett’s advice to be greedy when others are fearful and buy assets at discounted prices, you need capital. “Unlike many, I consider cash an asset class,” says Raymond James Chief Investment Strategist Jeff Saut. Having some cash available at all times may enable you to take advantage of appropriate investing opportunities when they present themselves.
Appeals to you if: You have the confidence – and capital – to take advantage of opportunities in volatile markets.
You don’t have to search too hard for ways to earn interest on your cash as the Federal Reserve has bumped up its benchmark rate. To be sure, interest rates on savings are still low relative to historic highs, but many prime money funds earn more than inflation – not to mention, many of those funds have outperformed other asset classes, according to Bloomberg.
“Bonds, in aggregate, have struggled as interest rates moved higher and spreads widened,” says Larry Adam, chief investment officer for Raymond James Private Client Group. In some cases, that makes cash a more appealing alternative to bonds when you’re seeking a counterweight to riskier assets.
Appeals to you if: You seek yield for minimal risk.
It’s helpful to think of cash as solving two needs: What you need today (everyday spending cash) and what you need in the future (savings and strategic cash). Ask your advisor to help you shop around for higher-yielding cash management accounts for your everyday spending, and cash alternatives for your strategic cash.
Strategic cash solutions can provide you the flexibility to remain invested, with ready access to your assets when needed. They help you avoid selling your longer term investments and disrupting your carefully crafted financial plan when you need liquidity. This may be particularly true for business owners – cash is critical for a growing company.
Appeals to you if: You have liquidity needs in the near term.
If market turbulence has you feeling edgy, increasing your allocation to cash might be the right prescription. That’s because in times of stock market volatility, cash tends to do well as a “defensive asset” with low or negative correlation with equities. Other assets used as a hedge against downturns, such as gold, are prone to price fluctuations. However, cash has low price volatility in comparison with other defensive assets.
Appeals to you if: You have concerns about market volatility.
Though cash has many benefits, moderation is key. There’s a reason investing pros do not recommend selling everything and burying the cash in your backyard. If you hold onto too much cash for too long, there’s an opportunity cost – you will miss out on the returns that other asset classes have to offer. You should also keep in mind the amount you could be losing to inflation when you maintain a large cash reserve.
When you and your advisor weigh the benefits and considerations, however, you might find you’ll want to stash a bit of strategic cash as a solution to some of your financial planning needs.
Every investor's situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Asset allocation and diversification do not ensure a profit or protect against a loss. U.S. Treasury securities are guaranteed by the U.S. government and, if held to maturity, offer a fixed rate of return and guaranteed principal value. Certificates of deposit offer FDIC insurance and a fixed rate of return. The market value of fixed income securities may be affected by several risks including interest rate risk, default or credit risk, and liquidity risk.