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How much cash should I hold as an investor?

Cash is an important consideration of any investor. How much should you have? When should you hold more cash?

Over the long-term cash is one of the worst investments to hold. The highest bank interest rates currently on offer are between 2.5% to 3%, which isn’t much better than inflation.

Cash can be great to have in your personal life as an emergency fund. It can pay for all sorts of ways to increase your earning power such as education or starting a new business.

Over the long-term the share market (with dividends re-invested) will keep going higher, however there are times when the market can take huge dips downwards. Cash is a great protection against this, it doesn’t lose value except for inflation.

In those large market dips, such as February 2016, having some cash in reserve will be a good position. Imagine being able to buy Challenger Ltd (ASX: CGF) or REA Group Limited (ASX: REA) after a 15% to 20% dip. The high-quality companies don’t often trade cheaply, so you need to have the cash on hand to take that opportunity.

Interest rates around the world are predicted to slowly increase over the next few years and share markets could soon become more volatile after a period of relative calm. The longer this bull market runs, the closer it gets to an inevitable dip again.

Some investors like WAM Capital Limited (ASX: WAM) have had cash levels over 35% in recent months. Other managers have had cash levels of 20%, 10% or even 5%. It really depends on the objectives and investment style of each investor.

Personally, I don’t have cash as a sizeable percentage of my portfolio. I regularly invest in whatever seems like the best value to me at the time. However, I do see the appeal of keeping a certain amount of gunpower dry, so perhaps in the future I will create that reserve cash pile.

Foolish takeaway

At the moment, I’d understand if investors want to keep a certain amount of cash on hand. There is a lot of uncertainty in the Australian and global markets. There are always reasons not to invest, so it’s probably better to stay invested for the long term in quality businesses.

The market has gotten cheaper in recent weeks so investors shouldn’t be afraid to put capital to work.

If you're stuck for ideas, these shares could be the perfect place to invest instead of holding cash.

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Motley Fool contributor Tristan Harrison owns shares of Challenger Limited and WAM Capital Limited. The Motley Fool Australia owns shares of Challenger Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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