There is lots of incredible analysis when it comes to finance and economics. However, a lot of it overlooks the simplest detail that is vital for any financial portfolio. While we cannot give you information that is specific to your circumstance, cash serves a critical role in any portfolio. It is often argued that cash cannot be a viable “investment” because it doesn't offer any return. But this analysis overlooks the optionality that cash provides to any portfolio, at any time. Every segment of your wealth is important, and that includes first and foremost cash because it allows you to make decisions that other investors with no cash allocation do not have the opportunity of making.

Cash In An Investment Portfolio

In an investment portfolio, your cash position should vary. This is cash that is outside of your savings, emergency fund, and daily expenses. The amount of cash you have as part of your investment portfolio should either depend on the business cycle or the amount of opportunities you see in the market. Specifically, if you are a long-only investor who likes to buy undervalued securities and hold them for a year or more, you want to increase your cash position when the business cycle is near its end such as when the yield curve has inverted. Cash doesn't provide much returns in a highly liquid money market account, but it provides you optionality. It's worth foregoing a small amount of opportunity cost when waiting for a decline in stocks because you'll get the opportunity to buy the decline at reduced valuations. The more money you have in cash before a bear market, the easier it will be to be aggressive while others are panicking as we discussed in What To Do In A Selloff? Conversely, having a small cash position in your account after equities have fallen in a bear market would make most sense if you have already taken advantage of discounted valuations. The more valuations fall the less reasons you need to invest. For example, if stocks are down a hypothetical 20%, you'll need to see improving data to be fully invested. However, if there is a decline of say more than 40%, based on the historical average decline during bear markets, it's relatively less risky to buy the index regardless of cyclical improvement.