What’s the right amount of cash for my portfolio?

Is there a benefit to holding cash in your portfolio? Learn more about types of cash assets, how much cash you may need, and the role it can play in your investments.

What do you mean by “cash”?

icon for cash in a portfolioThis isn’t about the cash in your wallet. For investors, cash is shorthand for assets that you can access quickly to cover an expense, so you don’t draw from other savings. Cash assets are useful in an emergency (such as a job loss) so you don’t need to tap into a retirement plan like a 401(k) or an IRA.

Types of cash assets:

  • Short-term treasury bills
  • Money market funds
  • FDIC-insured checking and savings accounts

What cash assets have in common:

  • They’re low risk and offer a low return
  • They’re liquid and easy to access
  • They’re not intended as a primary long-term investment

What’s the problem with keeping savings as cash?

Your money has less chance to grow when it’s held as cash. And in the long run, cash doesn’t help preserve purchasing power. Inflation, for example, can erode the purchasing power of cash.

Tuition and Medical Cost Increases Overshadow General Inflation*

Percentage increase in selected costs, 1978–2016

Source: Bloomberg, 12/31/2016
* As represented by CPI

When is cash the right choice?

  • When you sell a house or inherit some money and you need a little time to figure out where to invest.
  • When there’s a run-up in prices and it seems overheated, investors may want to attempt to avoid market risk by converting some investments to cash.
  • Planning for a big expense within a year or two, such as college tuition payment or a house purchase.
  • Emergencies, such as a job loss or a natural disaster.

iconf for diversification

When there’s a run-up in prices and it seems overheated, investors may want to attempt to avoid market risk by converting some investments to cash.

icon of graduation cap

Planning for a big expense within a year or two, such as college tuition payment or a house purchase.

icon of emergency symbol

Emergencies, such as a job loss or a natural disaster.

How much cash should be part of an emergency fund?

The general recommendation:

3 to 6

months

The general recommendation is to have three to six months of salary as an emergency fund, although that can vary. Consider these questions when deciding how much cash to hold in an emergency fund:

  • Are you a single earner or a two-earner couple?
  • How secure is your job?
  • Are you retired?
  • How comprehensive is your medical plan?
  • Are you prepared for a natural disaster that may damage your house or car?

What are my next steps if I’m holding too much cash?

illustration of cashConsider investing it in equal amounts over a period of several months.

That way:

  • You’re unlikely to invest all your cash at peak prices.
  • Your cash will buy more shares when prices are lower.
  • Your cash will buy fewer shares when they are higher.
  • Your portfolio may be biased toward lower-priced shares as a result.

This strategy is called “dollar-cost averaging,” which can take advantage of market volatility.

A periodic investment plan such as dollar cost averaging does not assure a profit or protect against a loss in declining markets. Since such a strategy involves continuous investment, the investor should consider his or her ability to continue purchases through periods of low price levels.

What are my key takeaways?

key takeaways icon

  1. Cash has important uses, but should not be a primary, long-term investment for most investors.
  2. For most investors, cash should not represent the majority of their asset allocation dollars.
  3. Investors tend to hold more cash than their investment professionals recommend.

All investments are subject to market risk which means their value may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors due to numerous factors some of which may be unpredictable. Be sure investors understand and are able to bear the associated market, liquidity, credit, yield fluctuation and other risks involved in an investment in a particular strategy.

Cash alternatives typically offer lower rates of return than longer-term equity or fixed-income securities and provide a level of liquidity and price stability generally not available to these investments. Some examples of cash alternatives include: Bank certificates of deposit; bank money market accounts; bankers’ acceptances, federal agency short-term securities, money market mutual funds, Treasury bills, ultra-short bond mutual funds or exchange-traded funds and variable rate demand notes. Each type of cash alternatives has advantages and disadvantages which should be discussed with your financial advisor before investing.

Wells Fargo Investment Institute is not a legal or tax advisor.

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