Optimal Cash Allocation

MaxiRobriguez

Morning -

Posing this question as I've always carried a cash allocation alongside my main stock holdings ready to "buy the dips" - but recently I've found that that cash allocation is growing beyond my comfort zone, but doing so only because I haven't been able to find any at-risk investment that I actually want to make. Nothing appeals based on their risk/reward and my current holdings, so my spare monthly money just sits waiting to be used...

I've often read over the last few weeks that asset managers' cash allocations are approaching record levels, but the articles suggest the allocations going from c.5% to what is now c.8%.  Guess my question is, does 8% allocation really make much a difference to overall portfolio performance in a sharp bear market where you can pick up assets on the cheap? If so, why not carry 10% or 15% cash? At what point does the cash allocation actually weigh on performance over the long run? Has there been any research into this or is it just gut feeling?

How do you, MSE forum, draw the line? What's your allocation to cash, if any? How do you personally define what your optimal split between at risk assets and cash is?

dunroving

For me, there are two primary reasons to hold "cash". Reason 1 is as a reserve to take advantage of dips in the market and buy undervalued stocks/sectors. Reason 2 is to use for expenses of normal living. 

You haven't said what stage you are at, but I am recently retired, and so Reason 2 is more important. Having focused on "building up" my pot, I now am focussed on "drawing down". Having lived through several crashes, and having been severely bitten in the tech crash, I assume a disaster might cause me have to hold my funds for up to 5 years to ride out a crash. So, my "cash" (held in premium bonds) is enough to fund up to 5 years of daily living, holidays, etc. If the market stays steady, I would keep topping this up by selling assets - so, spend a year of cash, top up a year of cash, etc. If there's a crash, I'd alway have 5 years of necessary cash to draw on until I can top up again when markets return to previous highs.

Regarding Reason 2, you raise an important question. I'm always reading "hold some cash to take advantage of good opportunities", but don't recall ever seeing clear guidance on what % of assets to hold in cash for this purpose. If you hold too little cash, a value opportunity won't yield much return. If you hold too much cash, and opportunities don't come up, you risk erosion of your cash by inflation. So, my answer is either, "I don't know", or, "depends on your attitude to risk".

MaxiRobriguez

Obviously don't mind the branch questions, but for my scenario specifically I'm asking about portfolio cash, not cash in a bank used for living expenses.

My specifics: I have, for the best part of the last half decade tried to keep my cash between a range of 5 and 10% - towards the higher end when risk/reward premiums seemed stretched, towards the lower end when the risk/reward premiums were more favourable. Currently though I have a cash allocation of 13% as I haven't purchased any capital-at-risk investments for a couple of months, and the money I put in every month from salary is about 3% of the total portfolio - so if I'm not buying anything, cash allocations quickly ramp up. I am mid 30's, this is a pension portfolio, so won't be accessing the cash for 25 years or so. I wouldn't be adverse to going 100% equity, I just don't think it's the optimal solution where markets are. I did some 'hindsight' analysis on my strategy and worked out I was a few £k better off with my approach than had I gone 100% equity from the start. So... that's why I'm asking the question. When is a certain amount of cash too much cash?

itwasntme001

I am similar age to you and I now hold a pretty sizeable amount in cash and wealth preservation funds.  I used to be around 80% stocks (trackers, managed funds and single stocks) but now I am more like 60%.  Prospective returns at current levels do not look good so risk/reward is not there any more.  I do not believe in buy and hold at any price long term and I do believe in "market timing" but only for a long/medium term fundamental view.  Short term (less than 5 years) is anyone's guess and all of that technical analysis rubbish is a waste of time.

I am well aware that cash is losing in real terms but currently we have very low inflation and I value the optionality that this cash brings higher than the lost real term value.

I strongly suspect that the next 10 years will not be favourable for risk assets for a variety of reasons.

coyrls

I don't hold any cash in my portfolio to "buy in the dips".

Prism

I hold only enough cash to pay the platform fees - so around 0.3%. Everything else is invested

dunroving

I keep a couple of hundred in cash, to pay fees also. If I were a lot earlier in my investing career, with a longer time frame, I'd probably keep 5% or so to pick up any bargains.

Notepad_Phil

The stats that I've seen would indicate that you're best off investing the money straight away, 'time in the market, not market timing', so that's what I've always done and have never kept money back to wait for dips.

It seems that for most of my 30+ years of investing that there have been people talking about stretched risk/reward premiums, as an early retired person in their 50's I'm just glad that I ignored them and just invested as the money came in.

Rollinghome

MaxiRobriguez said:

At what point does the cash allocation actually weigh on performance over the long run? Has there been any research into this or is it just gut feeling?

It's not difficult to find figures for returns on cash versus performance of investments but first you need to define what you mean.  The performance of what: UK stocks, US stocks, gilts, bonds, gold? More likely a mixture of some sort. Just as importantly, over what period? You can only measure with certainty against past performance but presumably of most interest is what will happen in the future.  That's nigh impossible to know even in normal times, let alone where we find ourselves now.

So it comes back to asking the old question of what's right for you.  How much risk can you sensibly take and how much will allow you to sleep at night.  What would the effect on you and your lifestyle be if you woke up to find your assets were now worth 50% less than the month before and would likely stay that way for X number of years. The answers will be different for every one of us dependent on our current wealth, our future income, our age, and our responsibilities.  Some will want, or need, to take considerable risk, while for others being 100% in cash might be the right approach.  There's no one size to fit all and no simple answer.

As an aside, historically, the return on cash currently isn't quite as bad many seem to think.  The CPI is stuck at 108.5 where it was in September 2019 to give an increase over the full year of just 0.50%. At the same time NS&I is paying 1.16% on easy access savings and for many there'll be no tax to pay on that.  Obviously for many of us the inflation rate we experience will be different to the notional CPI basket of goodies.

coachman12

I can only recount my own figure-----I keep 5% ( sometimes higher) of my total portfolio as cash.

kinger101

I'm less than 1% cash.  It's just there so I don't have to sell to cover fees.  I don't hold a reserve to buy the dip.  Largely because I know that any appearance that I'd successfully timed the market or otherwise would solely be luck.  There's no fixed periodicity to market cycles, or obvious boundaries indicating the dip is over.  Only a historic long-term upward trend.