In Fisher Investments’ experience, sharp market swings drive many investors to seek the perceived safety of cash. Other investors constantly carry a large cash cushion—likely much more than needed, based on their expected cash flow or other expenditures. However, Fisher Investments thinks cash’s role in growth-oriented, diversified portfolios is limited. Holding too much may be counterproductive and presents risks investors should be cognizant of.
To be clear, we aren’t anti-cash. An emergency cash reserve has its place in diversified portfolios in Fisher Investments’ view, as investors then don’t have to liquidate assets whenever an unexpected expense arises. Moreover, it may make sense to hold cash if you have large, known upcoming expenses or other short-term plans (e.g., money earmarked for a down payment on a property, a home remodel, etc.). Subjecting all your liquid assets to short-term market volatility could jeopardize your ability to meet such near-term needs. But holding huge cash cushions isn’t always wise and doesn’t equal added safety, in our view, as doing so can expose diversified portfolios to other risks.
In Fisher Investments’ experience, one reason investors hold big cash buffers is to help weather stock market volatility. Some are willing to forgo some long-term returns in exchange for less short-term turbulence. However, we think this view can amount to overlooking risks beyond volatility. Here is one: inflation, which historically has averaged 2.9% annually. [i] We think it is important to account for this steady erosion of cash’s buying power, especially since cash offers little to no growth—especially over the past decade-plus, given very low (currently near-zero) yields on money market funds and savings accounts.
Inflation’s silent tax notwithstanding, cash tends to water down returns during bull markets, leaving less money in your portfolio to compound over time. Consider a hypothetical $100,000 portfolio. Assuming an 8% annual stock market return over 15 years (below stocks’ long-term 10.2% annualized return), a 100% stock portfolio will grow to nearly $294,000. [ii] In contrast, a 75% stock/25% cash portfolio—with the same 8% market return but a 1% annual cash return—will rise to just under $234,000 over the same 15-year period. Now, stock market returns aren’t nearly that steady year to year, but we think this scenario helps illustrate cash’s dampening effect on diversified portfolios’ long-term growth.
We have also found investors hold cash as a source of “dry powder” to deploy when stocks get cheap. From a high level, the logic seems appealing—many investors have heard of the investing adage “buy low, sell high.” But reality is more complex, in our view, since markets don’t announce buying opportunities. Stocks can enjoy long stretches of rising prices, so holding cash while waiting for a dip may come with a big opportunity cost—akin to our aforementioned hypothetical example. In this scenario, many investors would likely be better off getting into the market and earning the price appreciation than waiting for the perfect moment to buy. Moreover, in Fisher Investments’ experience, the best times to buy are often periods when investors feel least willing to do so. Our research shows investor sentiment closely follows recent market movement, so when stocks may appear “cheap” is often when investor sentiment has turned dour. In that environment, we have found many investors prefer to wait for signs of a rebound before deploying their “spare cash.” Yet negative volatility can end as quickly as it starts, and by the time investors’ moods have perked up, the opportunity to “buy low” may be long gone.
Diversified portfolios have room for cash, but to figure out how much, determine your specific investment goals and objectives. Do you need long-term growth and/or have cash-flow needs? Do you have a large purchase around the corner? We think these questions should guide your asset allocation—your portfolio’s mix of stocks, bonds, cash and other types of securities. When reviewing your cash allocation, take note of dividend payments—particularly relevant for fund investors. Without action, those payments could pile up and sit unproductively idle, increasing your cash allotment without your realizing it. As a general rule of thumb, we think holding enough cash to meet between 3–12 months’ cash-flow needs is sufficient—and the long end of that spectrum may be on the extreme side.
Outside short-term expenses and emergency savings, holding too much cash in diversified portfolios can be costly, in Fisher Investments’ view. We understand the desire to buttress against uncomfortable volatility but, in our view, investors benefit more by reframing their view. Rather than as a negative to avoid at all costs, we suggest treating the market’s turbulence as the price to pay for stocks’ long-term gains. Holding too much cash may just end up flipping this risk around: short-term comfort in exchange for weaker long-term returns—a potential setback for diversified portfolios’ ability to provide for investors’ needs.
Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return. This document constitutes the general views of Fisher Investments and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.
[i] Source: Global Financial Data, as of 03/09/2021. US CPI, 1926–2020.
[ii] Ibid. S&P 500 annualized total return, January 1926–December 2020.