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How cash impacts investment portfolio

Having enough cash can sometimes be justified, at least because cash is the most liquid commodity you can use in case of an emergency.

For some people, it’s enough to have part of their portfolio in cash. I’m not going to criticize this approach because it can have its place.

However, people often save too much cash, especially when they are unsure of the market and economic outlook, so they prefer to save cash instead of investing their savings. As a result, they lose opportunities and don’t get the returns they would expect if they invested their savings, even in safe, low-risk assets.

The truth is, you first have to figure out when cash can be justified and when it will be detrimental and just be savings rather than an investment that would allow them to generate additional income and multiply what they already have.

Why you should have cash in your investment portfolio?

Cash in an investment portfolio has several advantages.

First of all, it gives you peace of mind, so you are less likely to make rash decisions to sell assets because you always have a safety cushion. It’s a good idea if you’re prone to anxiety or impulsive decisions, as it reduces the chance that you’ll sell an asset at the wrong time.

Second, cash can be useful in case of unforeseen circumstances. Cash is the most liquid asset you can have, so you can count on having a reserve of money you can use when you need it.

The most important thing you need to understand is the balance between liquidity and profitability. Of course, you shouldn’t invest every last cent, but you shouldn’t keep too much in cash either.

If you’re planning on making a major purchase in the not-too-distant future, however, you may not want to keep your money in cash, but invest in short-term assets. For example, in short-term bonds. This allows you to not put all of your money in cash, but invest some of it in short-term assets.

How cash can negatively impact your investment portfolio?

However, cash can also have a negative impact, which you should not forget. Especially if you invest too much of your portfolio in cash. Sure, cash gives you a sense of security, but it can make you lose out in the long run when you, instead of earning extra income, just keep the cash.

According to data from a recent study by UBS (Switzerland’s largest bank), the average U.S. investor now holds about 22% of their assets in cash, up from 14.1% in October 2020. And the rise in the cash share comes amid rising stock markets.

This would seem to be a paradoxical situation. However, 41% said they expect a downturn in the market, so they keep their money in cash. Another 48% are waiting for stock prices to fall so they can buy them when they are lower than justified.

Still, the main problem is fear – people feel uncertainty, so they prefer to keep some money in cash, as the most liquid type of assets.

Still, I don’t recommend keeping too much money in cash. And here’s why:

  • First, each day money loses some of its purchasing power because of inflation.
  • Second, cash is not profitable.
  • Finally, cash encourages you to make rash purchases and investments, especially as markets rise.

This can cause lost profit syndrome, when an investor sees that some stocks are rising too much, he may want to “catch up with the wave” and invest. However, such investments often occur at the peak, followed by a decline.

I think three reasons are enough to understand that keeping too much money in cash is a bad idea that can do you more harm than good.

What to do if you feel uncertain about investments?

It’s okay to feel uncertainty, but that doesn’t mean you have to hold on to cash.

However, if you’re waiting for stock markets to decline, it’s better not to keep your money in cash, but invest it in safe bonds. If the markets continue to rise, you’ll get a return on treasuries and if they go down, bonds will rise during the correction.

This will reduce the risk of the portfolio and give you an advantage in the event of any market movement.

So my advice is simple, there is no point in holding too much cash as it introduces too many problems.

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