Most investors hold their wealth in two types of instruments – shares and cash. Although bonds are sometimes thrown into the mix and you may also hold an investment property, shares and cash are both highly liquid and therefore merit the most consideration when it comes to weighting at any one time. Most successful investors have cash on hand at all times, either to take advantage of sudden pricing opportunities or as a hedge against the value of shares falling. With the S&P/ASX 200 (INDEXASX: XJO) index reaching new highs lately, it might be a good time to consider your own personal allocations.
How much cash should be in your portfolio?
This depends on the type of investor you are. If you are a self-funded retiree whose main concern is regular dividend payments, then it probably doesn’t make a lot of sense to keep a large chunk of your net worth in cash. With interest rates on a term deposit barely offering more than inflation these days, keeping large amounts of cash in these instruments is probably not the best use of your money.
Depending on your level of income and comfort with your current portfolio, you still may want to keep some powder dry for a time where dividend paying shares aren’t commanding the record prices they are today. If you can’t spare any capacity in your portfolio for extra cash on the sidelines, at least make sure you have confidence that your dividend paying companies can at least maintain their payouts if things get tough.
Shares like BHP Group Ltd (ASX: BHP) may be forced to cut dividends if the economy sours because historically, iron ore and oil prices fall significantly in the event of a global slowdown. Stocks like Woolworths Group Ltd (ASX: WOW) on the other hand, have far more flexibility as people don’t really stop buying groceries and other life essentials in tough times, so you can have more certainty of a consistent income.
If you are a value investor who doesn’t rely on income from shares, it might be a good time to start hoarding some cash. History tells us that shares don’t stay at record highs forever, so it might be a good opportunity to increase your firepower in case of a correction in the future. As Warren Buffett says, “when it’s raining gold [in a market crash], you want to go outside with a washtub, not a thimble.”
Depending on your personal circumstances, I personally think it is prudent to hold between 10–30% of your wealth in cash. There’s a saying that bull markets die on euphoria and the sharemarket is certainly feeling euphoric these days. It always pays to be cautious, and even if nothing happens, 70% of your assets are in still in the market.
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Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. 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.