What Would More Cash Do For You?
News of pension plans adding cash to their holdings may have investors wondering if they should follow suit. What does it mean to have more cash in your portfolio – and when's the right time? Bill Stone, CFA, CMT, PNC’s chief investment strategist, and Sean Flynn, CFA, CFP, PNC investment director, offer their insights.
POV: What is cash as an investment anyway?
Stone: Get rid of the mental picture of stuffing dollar bills under your mattress. Cash, in this sense, really refers to the money one has in a bank account or in other short-term financial instruments such as government bonds. Basically, it’s money that can be easily withdrawn for immediate use.
POV: Why is cash suddenly in the headlines?
Stone: In recent years, we have seen an increase in the number of institutional investors – the pension funds and mutual funds - shifting their asset allocations to hold more cash in their portfolios than ever before.
When combined with the market volatility in early 2016, this may have signaled to individual investors that these institutions were bracing for a down market. But we believe the rationale for these institutions is much more a function of short-term needs (described below) and not an indication for individual investors to follow course.
POV: Why are some funds holding more cash?
Stone: Think about your pension or 401k as an example. Pensions and mutual funds are tasked with growing the long-term value of their clients’ assets by investing in stocks and bonds, and then distributing those funds when the client requests it. Some clients receive their distributions at a regular frequency, some start redeeming at retirement, and some may request to withdraw anytime they want or need the funds.
We believe these large funds need more cash on-hand as a result of two major trends:
- Baby Boomers reaching retirement age. An unprecedented number of Americans born between 1946 and 1964 are reaching retirement age and are starting to withdraw from their pensions and retirement funds on which to live. Therefore, the fund managers are forced to keep more cash on-hand than ever before for this unprecedented amount of payouts.
- Increased redemptions due to market volatility. As is often the case in volatile markets, investors can get nervous about potential losses, and right or wrong, may withdraw funds from the markets. Pension fund and mutual fund managers acknowledge this possibility and may choose to have more cash available rather than risk short-term losses in a period where more of their clients may request redemptions.
POV: What should an individual investor make of this trend?
Flynn: Short-term or emergency needs aside, cash should not make up a significant part of an investor’s long-term strategy, primarily because they lose purchasing power as a result of inflation. I have heard many clients comment that "at least I can't lose anything if I hold cash." In reality, they won't see the amount fluctuate like a stock market investment, but they will lose value over time.
There are periods of time -- like the 1970s - early '80s in the U.S. -- when this can happen quite rapidly. Even in recent years when inflation has been relatively low, think about how much prices have gone up for things like cars, homes, or even your grocery bill.
For this reason, investors trying to save for retirement or other long-term goals need to hold assets that will appreciate at a rate equal to or greater than that of inflation. Investing in the stock market has historically been a reliable and efficient way to accomplish this, but individuals must be prepared to experience some periods of higher volatility and short-term price declines. High quality bonds may help reduce some of this volatility - and can also provide a reliable stream of cash.
POV: When does it make sense for an individual to hold cash?
Flynn: There are definitely reasons for individuals to hold higher shares of cash from time to time. The most common reasons are:
- Anticipated short-term needs: If you are expecting major expenses like home renovations, a home purchase, education costs, or tax payments, it’s a good idea to have cash easily available to avoid a tax event by withdrawing from investment funds or being forced to sell some stock when the market is down.
- Emergency fund for unanticipated expenses: Home repairs, broken appliances or medical expenses can all sneak up on us, and it’s better to have some cash reserved to cover these unforeseen expenses. The amount should be higher for individuals with a family who may have more unplanned expenses like children’s medical bills, a higher debt load, or those with unpredictable income streams like someone working on a commission or a business owner with cash flows that can vary from month to month.
POV: How much should one hold in cash versus invest for long-term growth?
Flynn: Knowing how to construct the right plan is a daunting task for most people, and truly varies so much person to person, family to family. It is so important to work with an advisor that can help you create a long-term investment strategy specific to your goals and risk tolerance. They can also be that voice of reason during periods of stress in the markets, preventing you from making emotional decisions like selling at just the wrong time.
At a minimum, you'll want to review your plan annually to make sure you're still on track to meet your goals and make changes if necessary. This should include rebalancing your portfolio to make sure your investments properly reflect your risk tolerance. Implementing this disciplined process even once per year will force you to buy low and sell high, and can add tremendous value in the long run.
Bill Stone says pensions and mutual funds have
more cash holdings mainly due to an increase
in retiree redemptions
Sean Flynn suggests keeping enough cash on hand for short-term expenses and an emergency reserve
What’s $100 Worth?
As prices go up over the years, the value of a dollar goes down. In 1915, a person with $4.26 could buy goods that today would cost about $100. The value in other years:
- 1980: $34.77
- 2000: $72.65
- 2010: $92.00
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