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Besides keeping some in an emergency fund, should the average investor have an allocation to cash and cash equivalents in an investment portfolio? The Wall Street Journal put this question to The Experts, an exclusive group of industry and thought leaders who engage in in-depth online discussions of topics from the print Report. This question relates to a recent article that discussed the merits of keeping cash in a stock fund's portfolio and formed the basis of a discussion in The Experts stream on Wednesday, May 8.The Experts will discuss topics raised in this month's Wealth Management Report and other Wall Street Journal Reports. Find the finance Experts online at WSJ.com/WealthReport.
Also be sure to watch three wealth-management thought leaders—Morningstar's Director of Personal Finance Christine Benz (@Christine_Benz), American Association of Individual Investors Vice President Charles Rotblut (@CharlesRotblut) and Portfolio Solutions Founder Rick Ferri (@Rick_Ferri)—speak about succeeding as a do-it-yourself investor in a video chat that aired on Monday, May 6.
Michelle Perry Higgins: In a Word, Absolutely.
In my opinion, absolutely. My rule of thumb for investors is that if you think you may need the funds within the next three years, then those dollars should probably be left in cash or cash equivalents. For example, if you plan to tap into your portfolio within the next few years for a home purchase, college or income needs, my advice would be to keep the funds in cash and call it a day. You can't afford to risk losing money in the stock or bond market with dollars you might actually need to have in hand within a few years. The stock market is notoriously good at tempting you to move out of cash and up the risk curve.
Michelle Perry Higgins (@RetirementMPH) is a financial planner and principal at California Financial Advisors.
In my opinion, absolutely. My rule of thumb for investors is that if you think you may need the funds within the next three years, then those dollars should probably be left in cash or cash equivalents. For example, if you plan to tap into your portfolio within the next few years for a home purchase, college or income needs, my advice would be to keep the funds in cash and call it a day. You can't afford to risk losing money in the stock or bond market with dollars you might actually need to have in hand within a few years. The stock market is notoriously good at tempting you to move out of cash and up the risk curve.
Michelle Perry Higgins (@RetirementMPH) is a financial planner and principal at California Financial Advisors.
Matt Hougan: In a Word, No.
No. Put your money to work.
Matt Hougan (@Matt_Hougan) is president of ETF analytics and global head of editorial for IndexUniverse LLC.
Tom Brakke: Cash Lets You Respond to OpportunitiesNo. Put your money to work.
Matt Hougan (@Matt_Hougan) is president of ETF analytics and global head of editorial for IndexUniverse LLC.
For investors who take a fully passive approach, it's probably not necessary. I think everyone else should have higher levels of cash today than they generally do.
That may seem counterintuitive given the low rates on cash, but cash provides flexibility during times when markets come under pressure. Being fully invested sounds great, but it prevents you from responding to opportunities.
Central banks around the world have driven the returns on cash to zero, and have caused distortions in the prices of more volatile assets. No one knows whether those policies will lead to nirvana or catastrophe, although we will undoubtedly end up somewhere in between those extremes. Sacrificing a little upside by holding extra cash right now is a good trade for having a cushion if this grand experiment goes awry.
(If you want to read a longer article on this topic, check out "Cash as Trash, Cash as King, and Cash as a Weapon," from the CFA Institute.)
Tom Brakke (@researchpuzzler) is a consultant, writer and investment adviser who specializes in the analysis of investment decision making and the communication of investment ideas.Rick Ferri: Cash Doesn't Earn a Thing
Cash isn't a good investment because after taxes and inflation, it doesn't earn anything. Today, it's actually a bad investment because inflation is higher than the return on cash.
Cash outside an emergency fund is useful if you have a large liability coming up. For example, your high-school senior is heading off to college and you're footing the bill. Personally, I'm stashing cash this year to pay higher taxes next April.
The only other reason to hold cash is if you're trying to time the markets. Good luck with that. I don't do it, which is one reason I have enough money to pay my taxes.
Rick Ferri is founder of Portfolio Solutions LLC and the author of six books on low-cost index fund and ETF investing. His blog is RickFerri.com.
Rafael Pardo: Liquidity Will Keep You From Robbing Peter to Pay Paul
Yes. As its name suggests, your emergency fund is intended (and should only be used) for emergencies, such as covering living expenses after the loss of a job. Once you deviate from this principle and begin raiding your emergency fund for nonemergency purposes (robbing Peter to pay Paul, as it were), you could find yourself in a heap of trouble. For example, an unforeseen investment opportunity is not an emergency, and yet that opportunity may be too good to pass up. To avoid the dilemma of foregoing the opportunity (and thus missing out on a potential gain) or seizing it (and thus potentially and irreversibly depleting your emergency fund), an allocation to cash in your investment portfolio will give you the liquidity to avail yourself of such an opportunity. And in doing so, you won't compromise the cushion you have built with your emergency fund to safeguard against unforeseen contingencies.
Rafael Pardo is the Robert T. Thompson professor of law at Emory University, where he specializes in bankruptcy and commercial law.
George Papadopoulos: You Need Some Cash for When Opportunity Knocks
I always like to have some cash lying around to take advantage of opportunities that may arise suddenly. Market corrections will always occur; you just never know when. With dividends and capital-gain distributions taken in cash and new cash added to portfolios, we find there is usually at least 5% sitting in cash. This cash came in handy in late 2008, of course. It is always easier to rebalance portfolios when you have available cash as it reduces or eliminates your need to sell a position, which increases transactions costs. The last thing we will do is make market timing calls and "go to all cash."
George Papadopoulos (@feeonlyplanner) is a fee-only wealth manager in Novi, Mich., serving affluent individuals and families.
Sheryl Garrett: Don't Think of Cash as an Investment
Put cash in your saving account and investments in your portfolio. The only cash that you may need in your investment portfolio is money to fund distributions, to enable you to take advantage of opportunities, or maybe you've simply met your objective or it's matured and you're awaiting reinvestment. Otherwise, cash is not an investment, and should not be included in your investment portfolio.
Sheryl Garrett (@SherylGarrett) is founder of the Garrett Planning Network Inc.
Greg McBride: Cash Becomes More Important With Age
An allocation to cash makes sense for many investors, regardless of age, as a way to diversify your portfolio, but is increasingly important as investors get closer to retirement. Particularly now, investors may opt for a little more cash at the expense of fixed income, given the nosebleed valuations in government bonds. Even for ultra-aggressive investors, a modest cash allocation gives you some investing ammunition when short-term market volatility reveals attractive bargains.
Greg McBride (@BankrateGreg) is a senior financial analyst and vice president for Bankrate.com, providing analysis and advice on personal finance.
Manisha Thakor: Keep Cash If You'll Use It Within the Next Seven Years
Whether or not you should be holding cash depends upon how you define your "investment portfolio." My personal rule of thumb is that money you know with certainty that you'll need to spend in the next seven years should not be invested in stocks or bonds. Rather it should be parked for safe keeping in cash equivalents (money-market funds, CDs, T-bills, etc.). The reason is that this frees you up to take full advantage of the risk/reward characteristics inherent in equity investing. In plain English, you can swing a little harder because you know you have a cash safety net. So if your definition of your "investment portfolio" is the sum total of funds that you have at your disposal to save and invest, then yes, there absolutely is a place. I also think cash is a fine parking place while you are trying to decide what you want to do, as rushed decisions can easily backfire.
However, if by contrast you are referring to your IRA or your 401(k) as your investment portfolio and you are not within seven years of planning to take distributions, then I prefer to see portfolios fully invested. The way I would temper the inevitable volatility that comes with investing is to take my "risk" on the equity side and using high quality municipals or treasurys (not corporates) on the fixed income side as a buffer. The idea of keeping some "cash on the sidelines" to put to work when opportunities arise to me sounds an awful lot like market timing—something that I view as strikingly close to gambling given it's long statistical history of failure.
Manisha Thakor (@ManishaThakor) is founder and chief executive of Santa Fe, N.M.-based MoneyZen Wealth Management LLC.
Larry Zimpleman: Leave Your Allocation at 5% or Less
Unless you are a very conservative investor, I would keep the allocation to cash and cash equivalents to a modest amount—say roughly 5% or less. The primary reason for keeping a cash allocation would be to try to move into and out of the market (i.e. market timing). Studies show consistently that market timing is rarely, if ever, successful. The best approach is to set a long-term asset allocation strategy and stay true to that (unless either your time frame for drawing on the assets changes or your tolerance for risk changes).
Larry D. Zimpleman is chairman, president and chief executive of Principal Financial Group.
Eleanor Blayney: Why and Where You Should Keep Cash
Yes and no. As we CFP professionals love to say, "It depends."
It depends on why and where you are holding this nonemergency cash. It also depends on what else you may be holding—namely, debt.
Take the "why" first. Many of us have short-term financial goals, like saving for a significant vacation in three years, or putting a deposit on a home in the next two years. These kinds of goals—assuming a time frame of five years or less—are suitably held in cash or equivalents in an account separate from emergency money. Keep the two separate so that you can be religious about never tapping the emergency fund except for bona fide, "oh-crap" emergencies. If you mingle the short-term money with the emergency money, before you know it you'll be raiding the emergency fund for things like new furniture or that pesky annual insurance premium you forgot to budget into this month's cash flow.
Now for the "where." It makes little sense to hold cash or cash equivalents in your qualified retirement portfolio, assuming you are not close to retirement or in the withdrawal stage. The primary reason to hold cash is for its liquidity. When you know you're going to need X-dollars in the near future, you want to be invested in something certain to be nominally worth X dollars at that time. Cash in a qualified retirement account loses all the benefits of its liquidity when you cannot withdraw it without paying a penalty.
Finally, consider your liabilities. It rarely makes sense to hold cash at today's negligible interest rates, when you have debt at rates that are more than 2% or 3% of what the cash is earning. If the cash is not needed in the short term (see "why" above), then the smarter investment move is to pay down or off the higher rate debt.
Eleanor Blayney (@EleanorBlayney) is consumer advocate of the Certified Financial Planner Board of Standards.
Charles Rotblut: Think About Your Time Frame
The answer depends on when you intend to spend the cash. If you have a big purchase (e.g. a house, a car, college tuition, etc.) within the next few years, then holding cash or a cash equivalent makes sense. It can also make sense for retirees to hold a few years of anticipated withdrawals in cash to fund withdrawals.
Money not needed for the long term should be allocated to a mixture of stocks and bonds. If a security or fund is sold and you are hoping to reinvest the proceeds at lower prices, set a deadline for doing so. For example, if you think stock prices will dip over the summer, set a deadline to invest the cash no later than Aug. 31. This gives you some flexibility, but will prevent you from staying in cash too long.
Charles Rotblut (@charlesrotblut) is a vice president with the American Association of Individual Investors.
Terrance Odean: How's Your Tolerance for Risk?
Besides the emergency fund, most investors should not hold a large portion of their investment portfolio in cash for liquidity purposes. Investors with higher risk aversion or shorter investment horizons may want to hold a portion of their portfolio in low-risk or risk-free assets (e.g., T-bills).
Terrance Odean is the Rudd Family Foundation professor and chair of the finance group at the Haas School of Business at the University of California, Berkeley.
May 9, 2013, 12:20 p.m. ET
Article from http://online.wsj.com/article/SB10001424127887324744104578471740280677464.html