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How much cash should you hold in your portfolio?

Over long periods of time cash is by far the worst asset to hold. Can you imagine over 20 years only earning 3% annually throughout that time? That’s barely better than inflation.

It’s important to keep an emergency fund on the side so that you can easily deal with your car breaking down or being unable to earn money for a short period of time.

However, in terms of creating investment returns cash is a poor choice.

That doesn’t necessarily mean you should be 100% invested either.

Some very capable fund managers like WAM Capital Limited (ASX: WAM) and Magellan Financial Group Ltd (ASX: MFG) hold significant amounts of cash for downside protection and opportunities if presented.

If the share market, or one of your favourite shares, falls 20% it would be quite frustrating to not have any cash to buy at cheap prices. Cash can accelerate returns over the long-term if you can deploy at the right time.

Fund managers usually have a fixed amount of capital they’re working with, whereas us regular investors are hopefully regularly adding additional money to the market all the time.

I don’t think it makes sense to sell some shares just to have some cash on the side unless there’s something wrong with those shares – such as if the valuation has become far too stretched. Some of Australia’s highest-performing fund managers are saying they are lightening their positions of growth stocks at the moment because of the stretched expectations.

Mr Market is always shouting prices at you every day. It’s up to you to decide if you want to buy shares from him or sell shares to him, or simply do nothing.

I think it is prudent to start holding a little cash on the side, but not too much. The growth shares are expensive, the cheap shares aren’t that cheap and stock indices as a whole don’t offer much upside right now. However, the market just keeps going up so it would be foolhardy to completely miss out on the growth.

It also depends on the shares you’re investing in. If all your shares have net cash (rather than debt) positions and have obvious long-term growth runways then they’re in a much safer spot than say unprofitable tech companies with significant debt on their balance sheets.

Foolish takeaway

If you find good value then you should still invest. Just because most other shares are expensive doesn’t mean that there aren’t a handful of attractive options. For example, I believe that Paragon Care Ltd (ASX: PGC) could be a solid performer over the next two years thanks to its low valuation, decent earnings growth and solid dividend yield.

Another share that looks great for boom or bust times is this top ASX share which is growing in Asia and Australia whilst continually growing its dividend.

You might not know this market leader's name, but it's rapidly expanding into a highly profitable niche market here in Australia. Even better, the shares boast a strong, fully franked dividend that should balloon in the years to come. In other words, we're looking at the holy grail of incredible long-term growth potential AND income you can watch accruing in your account in real time!

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Motley Fool contributor Tristan Harrison owns shares of Paragon Care Limited. The Motley Fool Australia has recommended Paragon Care 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 Scott Phillips.

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