I have been digging into portfolio design a lot lately and will trickle a few posts out before bringing all of my thoughts together. One area to think about in building a great portfolio is the cash that you hold in your account. Some investors think of this cash as a necessary evil, some think of it as not being a position – but money on the sidelines waiting for investment, some have all sorts of other ideas about how much it should be returning, etc.
For me, Cash is a position.
I mean it doesn’t need to return anything really. It is a part of my portfolio though and especially now with the run up in the markets being so large, having cash or increasing a cash position is easy considering the other positions have been able to return so much. Think about it this way…
If your entire portfolio is invested in stocks, bonds, etc. Your entire net worth is dependent on the price at which you’ll be able to sell those assets. This works great to grow your assets relative to inflation; however, it doesn’t do much in terms of managing your entire portfolio. If you have $100k invested your “portfolio” and $100k sitting on the sidelines you really only have half of your invest-able assets allocated even if you want to call it fully invested. The trick is that if the $100k you have invested in the market returns 10%, you have really only returned 5% for your invest-able assets.
What you should be thinking about is your entire portfolio (exchange traded, privately traded, real estate, cash, etc.). If you take all this into account and have $100k invested and $100k in cash, you need to return 20% on your invested assets to return 10% for your portfolio. This is a much different view and it is also much harder to do; however, it is a more honest view of the world and it removes you from managing your cash separately from your invested assets.
The investments you have need to earn enough of a return to account for inflation and return requirements of your entire portfolio. When you start to look at it this way, it is much easier to break down your investments and focus on the few activities that you can do to affect your entire portfolio. Worrying about where to park your cash so it earns an extra tenth of a percent is time consuming and while you should try to park it somewhere with a return, you will be far better off focusing on the invested assets and getting them to perform better or simply not lose as much. That later activity will have a much more significant affect on your entire portfolio.