Why Cash Is King

Cash Is King. We've heard that phrase bantered about, but it's never more true than in investing. It's important to remember why people should have cash in their portfolio and what it's designed to do. Cash is the "least sexy" of the investments—after all, it just sits there, earning a pittance in interest, and you have no chance of seeing it double or triple. Why bother? Here are some compelling reasons to keep cash on hand in your portfolio.

  1. Life Hands You A Curveball. Sometimes an emergency comes up in your life and you have to dip into your portfolio in order to handle it. Yes, we have all vowed to never touch our investing nest egg, but what if you were in a serious car accident and suddenly needed $10,000—right now? Instead of pulling money from a long-term asset, you can access a money market account and pull the cash out with a minimal (or no) fee.
  2. The Market Crashes. The only thing worse than watching the market drop 700 points is watching it happen and not having any more money to buy more stocks. No matter how great the market seems to be going, there will be a day when everything goes in the tank. Having cash on hand to sweep in quickly when others are running for the exits is the easiest way to make money in the stock market.
  3. Sleep At Night. Some people just don't like risk, and as such part of their diversification should be cash. "Cash" means a money market fund, T-bills, or basically any interest-bearing security where you can get at it easily and quickly. Don't discount this factor—there's no point in earning tons of money if you are going to have be stressed out and no fun to live with.

How much cash should you have in your portfolio? Of course, it depends on your portfolio size, but I've always found that a few thousand (minimum) does the trick. You want enough on hand that you can buy 100 shares of a stock on your "watch list" if it dips considerably. That may be anywhere from $3,000 to $20,000, depending on the companies you are interested in and how bearish you are on the market's future.

Comments

  1. Posted by Blain Reinkensmeyer on November 8, 2007 at 2:25 pm

    This is a perfect article for the market where is at. Even with the NASDAQ down over 3% right now you still have gold holding up. Gotta love it. The QID us up 8% today as btw, congrats to the shorts. :twisted:

  2. Posted by Jorge on November 8, 2007 at 2:32 pm

    My general rule (after learning the hard way) is to have 10% of my total portfolio value in cash for days just like this (although I won't trade anything until DJIA hits 13k and the S&P hits 1420... technicals have broken down badly).

  3. Posted by Webomatica on November 8, 2007 at 2:33 pm

    Yep having a cash cushion is smart (although I don't go so far as to literally stuff it in the mattress) but here's a question for a future post - any worries about the dropping dollar? At what point should that cash be moved into foreign currency or gold?

  4. Posted by Blain Reinkensmeyer on November 8, 2007 at 2:39 pm

    I mentioned Gold on this blog back in September when GLD was at $72,

    http://www.stocktradingtogo.com/2007/09/20/the-easy-way-to-invest-in-gold-buy-the-etf/

    And still think it is a smart hold especially because of the dropping dollar. A balanced portfolio right now would have a good chunk of cash (perhaps 50%), some QID, GLD, and have a small investment emerging markets with EEM being the best play there.

  5. Posted by The Investor's Journal on November 8, 2007 at 2:58 pm

    I've had over half my portfolio in cash (etrade 5.05% apr saving accounts, actually :grin: ) for the last 4 months just because of the risk I've seen in the market.

  6. Posted by Jorge on November 8, 2007 at 3:15 pm

    I went 90% cash this morning. I knew the markets were going down but never pulled the trigger on puts. I was upset when I came home and realized how bad the markets broke down.

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