I hear this quite a bit. People see investors who talk openly about their strategies and hidden in their discussion is how much cash they keep on hand. It’s usually a throwaway comment, which is probably why people think they are really missing something as it comes off like something that everyone knows. Here are the two things you are likely thinking, and then here is what they actually mean.
#1. It’s not cash as is hundreds in a brief case.
This is not actually cash, like you would use to buy beers at the ballgame. What people mean when they say we keep 5% in cash is not physical bills, but anything that is not invested. This will become more clear in a second. But short answer: not actual cash.
#2. Why have that money digitally and not invest it?
This one I get a lot. You already have it in an account. It’s like you got all the way to the goal line and took a knee. Why keep 10% in cash in your brokerage account? How about putting that into a money market and at least making a few lousy fractions of a point on it?
Here’s why. Let’s say you have $200k in your brokerage account and 10% in cash or $20k in cash (funds not invested). First, again, this is how people mean this when you hear it. Here’s the reason and in a second I’ll explain why the % in cash also changes.
If you hold 10% in a market that has been soaring, we know from studying the trends that on average every 13 months the market will take a 10% hit. Such as today on Dec 30, 2017, we haven’t seen a significant drop was Feb 2016 so we are long overdue on the averages. This is typically thought of as a correction line in retrospect, but always thought of as the end of the world as it’s happening. The market is just settling, and then at some point it returns.
Now. During these times–and also other times when companies or bonds or funds you like are being undervalued–when you have cash on hand, you can invest in things when there is a price reduction. If you don’t have cash on hand, then you miss out on some good deals. And crucially, here is the point: it takes time to get cash of any size into an into an account, at minimum 3-5 days from the time you execute the transfer. However, if you aren’t on top of it immediately, this adds time. If it happens over a weekend or a holiday, this adds time.
So cash keeps you lose and ready to pounce when something happens.
Fluctuating Cash Amounts
Depending on your age and your investing type and the market, you might hold 5% and you might hold 20%. Right now, for example, I’m looking to add a percent each month waiting on the drop to get in. After the drop and the big invest, given my age and risk profile, I might only hold 1-2% for a while until the market stabilizes. By that point, I might be leveraged enough, I might not be. I might have extra cash, who knows? The point is that you need to use cash to your market advantage.