3 reasons why you should always hold some cash

A tricky question for investors is always ‘how much cash should I hold?’ Some people, like myself, are almost always fully invested. I’m a young investor, I regularly add to my investment account, and I work in a job that lets me follow my investments every day.

This may not necessarily be right for you. So what sort of things should you consider when deciding how much cash to hold?

  • The size of your portfolio

As a young investor, my portfolio is small. I estimate in about another two years of regular saving, I could double the size of the portfolio. That means that, assuming my shares don’t grow, in two years I’ll have 50% of my portfolio in cash. As long as I keep my job, I’m not overly concerned about how much cash I hold, because it’s growing meaningfully all the time.

If, however, your portfolio is say $500,000 after a lifetime of savings and it is hard for you to add meaningfully to this, then you should almost certainly hold a lot more cash than I do.

(That’s a separate consideration from how much of your total investment portfolio you should allocate to cash, bonds, and property, by the way. That allocation will depend on your life circumstances and other considerations raised by a financial adviser.)

  • The opportunities available

Is the market full of great shares trading at knock-down prices?  Or, like now, are many shares looking relatively expensive? Some companies like XERO FPO NZX (ASX: XRO) and Fisher & Paykel Healthcare Corp Ltd (ASX: FPH) are unquestionably great businesses, but they also look expensive.

Holding cash is great for future ‘optionality’ which is a fancy word that means ‘the freedom to buy great businesses if they suddenly go on sale’, like during a market crash.

  • The risks in the market

Does the market seem risky to you?

If you’re worried about a market crash, one of the easiest things to do is hold cash. Forget about owning options or other complicated hedging vehicles. If you think the market could crash, have some cash on hand. Not only will this insulate you from the worst of the crash, it could let your portfolio perform better afterwards, when you buy good shares trading at now-lower prices.

Overall, there are a lot of good reasons to hold cash, and having cash on hand can be an important contributor to your investment performance throughout the cycle.

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Motley Fool contributor Sean O'Neill owns shares of Xero. The Motley Fool Australia owns shares of Xero. 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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