Article Updated August 7, 2019
Should your investment portfolio have 90% in stock and bonds and 10% in cash? Or should it have 60% in stocks and bonds and 40% in cash?
The most common recommendation for the cash allocation in a portfolio is simply to use the percentage from a standard asset allocation model based on your age and risk tolerance.
But investors can adjust the percentage of cash in a portfolio to lower risk while building wealth by thinking beyond standard asset allocation models.
This can be accomplished by considering stock market valuations, long term trends and the economic cycle at any given time.
In this post I’ll share what I’ve learned about how much of my portfolio should be in cash through my AFC® (Accredited Financial Counselor) credentials but more so from almost 40 years now of personally investing.
I’ve discovered that having the right amount of cash in your portfolio is super important because it allows you to be at peace with investing and manage risk while building wealth.
Having Cash in Your Portfolio Feels Safe
It can be hard to know the best cash allocation in your portfolio because your hard earned savings feels safest in cash type of investments, for sure.
The emotional thinking tied to safety, however, can lead to avoiding investing.
And avoiding investing can lead to not having enough money to retire when you want and live the lifestyle you want.
By investing based on data, history and facts, instead of emotions, I’ve discovered that I make better investment decisions.
Investing can be scary, so this is something I had to learn to do, especially as the daughter of depression era parents and now that I am older.
This post presents both traditional suggestions for portfolio cash allocations along with facts and data to help you assess how much cash you should keep in your portfolio.
Net Worth Cash Percentage Vs Cash Allocation in Portfolio
It’s important to note here that the percentage of net worth in cash is different but closely related to the cash allocation in a portfolio.
Here’s why: Net worth includes your home and other assets while a traditional investment portfolio includes stocks, bonds and some cash.
Also, net worth cash can include money to be used for extraordinary expenses. It can be slightly more accessible than portfolio cash for convenience and structure.
Some financial planners call this an Emergency Fund but I structure our cash with a slightly different structure.
On the other hand, portfolio cash is money that has been put aside specifically for building wealth. While you may change the percent of cash in your portfolio as explained below, think of it as being out of reach for everything except true emergencies.
For this reason, I have written a separate post about how much cash to hold in a portfolio vs cash as a percentage of net worth. You can click here to read it but be sure to come back because both cash allocations are super important to reduce risk while building wealth.
What Is Portfolio Cash?
There’s one more important thing to note before getting into the cash allocation percentages.
Portfolio Cash Is Not Really Cash
Ideally, portfolio cash is not really cash. What is referred to as portfolio cash is usually money that’s put into a money market account or similar fund that pays interest.
The financial lingo that is used for portfolio cash is “cash equivalents”. That sounds really complicated so we’ll just call it cash in this post to keep things simple and lingo free.
But it’s important to remember it’s not really in cash because you want to earn interest on it.
Things to Check for Your Portfolio Cash
A money market fund will be like cash because it does not change in value but it does pay interest, unlike true cash. Ignoring inflation, the value stays at $1, though, just like cash.
It’s important to make sure that the value of wherever your “portfolio cash” is does not fluctuate. Otherwise, it is not really “portfolio cash” at all since it could lose value.
Don’t make assumptions that the money in your brokerage or investment account is automatically in the best money market. There are thousands of money markets.
Comparing Interest Rates on Portfolio Cash
Check to see if there is a money market that pays a higher interest rate with lower fees than what you are currently in.
I find the best money market at the brokerage firms we already use so I don’t have to move money to a new brokerage firm just to get another .50% in interest.
But I will tell you that one firm we use has a meaningfully higher money market return and lower fees than the other. For this reason, I have been considering moving some portfolio cash to the better money market now that rates have gotten a little higher.
Portfolio Cash Fees
Fees add insult to injury on already paltry interest rates that money markets pay. Check the fees you are paying on cash in your portfolio.
Insurance on Portfolio Cash
Also, quickly check the insurance levels (online in writing) if you are a high net worth investor to make sure your “cash” is insured. It probably is, but why not make sure just in case another financial crisis happens?
Since it has happened a couple of times before in the distant past it’s risky to just assume it won’t happen again.
How Much of Your Portfolio Should Be in Cash
Now that we have addressed the safety of portfolio cash, the difference between net worth cash and portfolio cash, and defined portfolio cash, let’s address how much portfolio cash to have.
The First Step Is to Choose an Investing Method
The first step to is to make one of two decisions. Neither decision is wrong, but they will probably get different outcomes.
And making this decision will keep you from worrying about having enough cash in your portfolio because you will have evaluated all the facts and decided with clarity from that place of knowledge.
Here’s the decision: Make a conscious decision to be a passive “buy and hold” investor OR an investor that prefers to sell stocks as they become expensive and buy stocks when they are cheap, as explained more in method 2 below.
We begin with this decision because it will have a meaningful impact on how much cash you should have in your portfolio as explained below.
Method 1 – Portfolio Percentage for Cash, Stocks and Bonds Using Asset Allocation
The most common recommendation for cash allocation in portfolios is based on passive long term buy and hold investing. This is what you’ll hear from popular Dave Ramsey and 95% of financial advisors and wealth managers.
Traditional investing uses a standard asset allocation model based on your age and risk tolerance to determine how much of your portfolio should be in cash, stocks and bonds as explained earlier.
This is also most the common portfolio cash allocation method among financial advisors, retirement investing institutions and individual investors.
But more experienced investors and tactical high net worth wealth managers use a different strategy to determine how much cash to keep in a portfolio as explained in method 2 below.
Asset Allocation Example
A common portfolio asset allocation for a moderate to low risk investor that is 50 years old is 50% in stocks, 35% in bonds and 15% in cash (money market), for example.
If you’re confused, click here to read my post How to Understand Your Investments where “asset allocation” is explained more.
The Goal of Asset Allocation Among Cash, Stocks and Bonds
The goal with asset allocation is to lower risk and reduce the need for increased portfolio cash, thereby allowing an investor to maximize portfolio returns.
For standard asset allocation to work for lowering risk, though, bonds must increase in value when stocks go down.
This usually happens but it doesn’t always happen as expected as explained more below.
For this reason, many investors increase cash in their portfolios to lower risk, in addition to, or even instead of, increasing the amount allocated to bonds.
Re-balancing to Desired Cash Allocation
With asset allocation investing, keeping the percentage of portfolio cash, stocks and bonds consistent over time doesn’t happen on its’ own.
Here is how it works.
Once a year (or other time frame) the portfolio is re-balanced portfolio with the asset allocation method.
This simply means that stocks and bonds are bought or sold so that the portfolio allocation to cash and other investments is restored to the desired level.
This portfolio cash allocation model is incredibly simple. An asset allocation investing method can work well if you have decades to invest passively in stocks and bonds.
Problems with Using Standard Asset Allocation for Cash Portfolio Percentages
Like me, you may not have the luxury of decades to invest before retirement. Or you may not want to wait years to save enough money for retirement, especially if your work is not fulfilling.
Again, this asset allocation investing method keeps investors in the same percentage of cash, stocks and bonds no matter how expensive or cheap stocks or bonds get.
The biggest problem with the standard asset allocation model is that it tends to keep investors with a low percentage of portfolio cash. While this works well in bull markets, it’s bad in bear markets because investor’s net worth declines when stocks decline.
The biggest drawback is that investors don’t have money to buy undervalued stocks after the bear market which is a great way to catch up wealth building.
Good News and Bad News
The good news for buy and hold investors is that eventually stocks return to the value they were before the bear market, and another bull market resumes.
Unfortunately, this process can take several years, which can be problematic, especially for soon to be retirees who were close to their retirement goal before the bear market.
An alternative to passive long term investing is what I call valuation investing as explained in the very next section.
I don’t want to TMI (Too Much Information) you when all you wanted to know what how much cash should be in your portfolio.
But having enough cash in your portfolio is crucial to reduce risk while building wealth so stay with me while I share the next method that affects portfolio cash percentages.
As always, I refuse to gloss over the reality here at Retire Certain.
Given the above information, the next step is still to decide whether to be an easy passive buy and hold investor or invest more proactively with a consideration of trends and valuations.
A lot of individual investors don’t see this as a choice because it is a little outside of mainstream investing.
Method 2 –Portfolio Cash Allocation for Valuation Investors
Valuation investors adjust their portfolio cash allocation based on values, long term and broad trends in stocks and bonds. This method suits investors who want to sell assets such as stocks as they become more expensive and buy stocks when they are cheap.
Buying low cost assets is a hallmark of wealth building.
My Big Epiphany about Raising Portfolio Cash
After investing through a few painful bear markets, both alone and with financial advisors, I had a big epiphany after seeing the abundant opportunities once the bear markets ended.
Here is my big epiphany: If you increase portfolio cash when markets get expensive you have cash to buy assets when they are cheap later on.
So, at this point in my life, I’ve been through too many bear markets and recessions to ignore expensive stock markets that have always been followed by undervalued stocks, so I like to increase the ratio of cash to investments as markets get riskier (more expensive).
With the valuation investing method, overall markets, the economy and asset valuations relative to historical prices are all considered before deciding how much of your portfolio should be in cash.
This method naturally provides portfolio cash to buy undervalued assets when they are plentiful after bear markets which have pulled stock prices back below long term average valuations.
With method 1 above, based on a standard asset allocation model, almost all your portfolio cash is invested when stocks and other assets get cheap every few years.
Click here to read my article How to Know if the Stock Market Will Go Up or Down and see #1 about markets reverting to the mean (average) over time.
With this method, while I will miss some of the profits during and near the end of a bull market, it is a trade off I am willing to endure to lower investment risk and allow me to take advantage of lower valuations after bear markets.
Only you can decide what is right for you based on your risk tolerance and other factors.
Click here to read my post How Will a Stock Market Crash Affect Me? If you’re curious how it will affect you, do my simple Stock Drop Factor in the post to see!
Why Doesn’t Everyone Keep Enough Portfolio Cash to Sell High and Buy Low
You’re probably wondering why everyone doesn’t do this since buying low cost (instead of expensive) assets is so logical.
While it may sound great to sell stocks when they are expensive thereby locking in profits, and buy stocks when they are dirt cheap, you must increase portfolio cash by selling stocks as stocks perform better and better for this to work.
That’s hard to do unless you have made a conscious decision to do so and accepted that you will miss some of the upside as stocks continue to climb.
That’s why Step 1 in this post is to make a clear decision about whether to invest with a standard asset allocation in cash, stocks and bonds no matter what valuations are, OR invest based on valuations.
If you want to take advantage of cheap asset valuations, you have to raise portfolio cash in bull (increasing) markets to do it or you won’t have the cash.
Yet individual investors tend to avoid considering trends and valuations when determining their portfolio cash allocation for several reasons.
It’s Hard to Think Differently
The biggest reason investors ignore valuations is because mainstream thinking convinces investors that they can’t figure out how to allocate investments among cash, stocks, and bonds based on valuations and what’s happening in the economy.
But it’s my opinion that every investor who chooses can understand this basic financial concept.
You Can Be Wrong and End Up with Too Much Cash in Your Portfolio
It is worth repeating that if you invest based on market valuations, you can be wrong about when the stock market will decline.
This usually results in having too much cash in your portfolio and missing out on some of the profits from bull (increasing) market trends.
Yet you’re sitting pretty when bear markets do happen.
You can also be wrong about when stocks will rise again.
But it’s easier to be right about when stocks are very undervalued after bear markets end because the math is clear and everyone hates stocks.
And individual investors aren’t the only ones who are wrong about investing based on market valuations. Many financial advisors and experts get this wrong, too.
Or more commonly, financial professionals promote sticking to a standard asset allocation (model 1 above) no matter what valuations are.
This is what is taught to new investors and those who just don’t want to be bothered with investing beyond asset allocations.
Plus, going out on a limb about stock market direction takes bravery because the timing is rarely perfect.
Passive Investing Is Easier
It’s easier to “buy and hold” stocks and bonds using a standard asset allocation than it is to alter the percentage you keep in cash, stocks and bonds based on valuations.
Let’s face it. The standard asset allocation model is not rocket science. It’s easy.
And it’s easier to not pay attention to the economy or the stock valuations. But I do think that most stock investors already do pay attention because they are worried about their stocks.
Investors Are Encouraged to Have a Set Percentage in Stocks, Bonds and Cash No Matter What
Mainstream media discourages anything other than passive investing. Again, passive investing with set asset allocation models is how most financial advisors invest for their clients.
Most people like to follow commonly accepted practices rather than question them and consider being a contrarian investor. We are herd beings.
And investors are led to believe it’s riskier to raise cash levels when markets become over valued, but this really makes no sense since buying assets at lower costs naturally lowers risk.
And for investors who have raised portfolio cash in response to expensive markets, buying less risky, lower cost stocks is possible since they will have the cash to buy them.
Even If You Have Cash in Your Portfolio the Herd Mentality Usually Wins
After bear markets, it’s very hard to go against the herd even when you have cash in your portfolio to buy cheap assets. When stocks are cheap after a bear market, everyone hates stocks and swear they’ll never invest in stocks again.
This drives the valuations even lower. This is when undervalued investments are rampant, but investors often don’t invest then due to all the fear and uncertainty.
This is when investing with facts, data and historical information instead of emotions can build wealth.
And if cheap assets that also generate income are bought, investors can be well positioned for retirement.
The same thing happens when real estate is cheap as I have experienced several times as an investor.
This same extremely low valuation experience happened with municipal bonds in the early 1980’s. This is when my dad bought as many municipal bonds as he could and changed my parent’s lifestyle with tax free yields up to 25%!
This is a lesson that stuck with me.
History repeats, over and over again.
With investing, you only live through these economic cycles a few times while you have enough money for it to matter. But you can look at over 100 years of stock market history to get the facts and historical data.
Fees and Inflation Eat Portfolio Cash Returns
There are two more problems worth mentioning with moving to a higher cash to investment ratio while you’re waiting on low valuations to return to stocks.
First, assuming inflation is around 2%, the yield on cash in money markets is almost, if not completely, gone toward inflation. This is called a negative real return.
That’s hard to get excited about. Yet in 2018 cash was the top performing sector from among US and international stocks and bonds, and real estate (REIT’s)!
Second, many investors pay wealth management fees on investment cash as addressed earlier. This seems fair since managing portfolio “cash” is part of an overall investment plan, especially if the wealth manager is more tactical.
After both wealth management fees and inflation, investors are left with a negative return on cash.
An investor must decide if lowering investment risk through a higher portfolio cash percentage is worth the potential negative return as compared to suffering through bear stock markets.
But ideally, valuation investors will not have a large percentage of portfolio cash for long enough for this negative to outweigh the benefits of being able to buy assets at lower valuations after bear markets.
How Much Cash to Have in Your Portfolio If You Invest Based on Valuations
There is no set rule for the best cash allocation in portfolios for investors who factor in valuations and trends but there are some factors to consider.
One factor which will affect portfolio cash allocations is the amount you have in Treasury bonds as covered more below.
Other factors are your risk tolerance, your level of confidence in a change in the economy and how much net worth you have.
High Net Worth Wealth Managers
Again, investing with a standard and common asset allocation no matter what the market valuations or trends are is most common.
But behind the scenes, many sophisticated high net worth wealth managers are lowering risk for their clients.
They may be using stock hedging strategies, increasing the ratio of portfolio cash or investing in assets that move counter to stocks as stock market valuations increase.
When stock markets become expensive, many more proactive high net worth wealth managers increase portfolio cash to 50% or more.
This is because high net worth investors are usually savvier about economic cycles, market trends and valuations. They demand more from their wealth managers.
And many more experienced individual investors employ similar risk reducing strategies as markets become expensive.
In August of 2019 after over 10 years of a strong bull market, Berkshire Hathaway showed in its second quarter results, it had accumulated a record $122.4 billion in cash and cash equivalents.
Berkshire is, of course, run by legendary investor Warren Buffett, well known for buying undervalued assets.
Buffett’s investment advice is offered in his famous quote “Be Fearful When Others Are Greedy and Greedy When Others Are Fearful.”
This quote supports raising cash when assets are expensive and buying them when assets are cheap, or Method 2 in this post.
Factor Based Investing
As quantitative data analysis improves, more investment products are being offered to more experienced investors. This is a type of investing called Factor Based Investing.
Factor based investing overlaps with what I call valuation investing but Factor Based is much more extensive.
Times are changing as individual investors become more sophisticated given the available information, data and technology.
Perhaps there is an important takeaway for all investors here.
Combining Valuation Investing with Passive Investing to Determine Cash Allocation
What I have learned from almost 4 decades of investing is that when you avoid extremes you can be right even when you’re wrong. For this reason, I like to combine some passive buy and hold investing with investing based on trends and valuations.
By raising the percentage of cash in my portfolio gradually when stocks get overvalued, for example, I can have cash available for lower risk, lower cost opportunities.
It is worth repeating that lower cost investments build wealth over time as markets ease back to overvalued territory.
Income from Dividend Stocks
By having some passive income investments, I can still build wealth even if I am wrong about exactly when stock market (or real estate) trends will change. This is because I can collect dividends for my stock allocation even when (not IF) stock markets decline.
Here is a video I did entitled Is Dividend Investing Worth It where I talk more about valuations on dividend paying stocks.
Remember, though, that inherently dividend yields are higher the cheaper stocks get since the dividend divided by the stock cost equals the dividend yield.
For this reason, I like stocks with dividends that are considerably higher than the S&P 500.
Then I can tweak the portfolio cash allocation and the stock allocation based on market valuations and other factors.
Do Treasury Bonds Go Up When Stocks Go Down?
The saving grace for asset allocation investors during bear markets is that, based on history, US Treasury bonds have almost always increased in value when U.S. stocks tanked. Assuming it happens in future bear markets, this increase in Treasury bonds will offset at least some of the decrease in stocks.
Unfortunately, the Treasury bond gain does not offset all of the stock loss in bear markets for most investors because:
- Stock losses are usually bigger than Treasury bond gains
- Most investors have significantly more in stocks than in Treasury bonds
Not only this, but many older investors have been encouraged to invest a higher allocation in stocks than previous decades so they can “catch up” their savings. Yikes!
Bonds Vs Cash to Lower Portfolio Risk
The percentage of your portfolio in Treasury bonds is also a huge factor in deciding how much of your portfolio should be in cash since Treasury bonds usually rise when stocks fall as explained above.
This is because both cash and Treasury bonds tend to offset risk when stocks decline.
Is cash (money market) or Treasury bonds better to lower investment risk?
Pros for Bonds Vs Cash
Treasury bonds have more price fluctuation than cash. This allows investors to experience a potential (and typical) increase in the bond portion of their portfolio when stocks go down.
Cash in a money market, on the other hand, does not increase or decrease in value.
Bonds also usually pay higher interest than bonds unless there is an inverted yield curve.
Cons for Bonds Vs Cash
The problem with bonds vs cash in portfolios is that there are no consistently perfect investments that move opposite stocks, including Treasury bonds.
This is why many investors simply increase portfolio cash percentages to reduce risk.
With portfolio cash invested in a well chosen money market fund, at least your investment will not drop in value.
But this means portfolio cash has no potential to increase in value either, unlike bonds.
Many investors think all bonds will behave like Treasury bonds but they don’t. Corporate and other types of bonds can also go down in value just like stocks do in bear markets and corrections due to the higher perceived risk.
While Treasury bonds are more likely to move counter to stocks due to their safety perception, the fact that overall risk increases during recessions (and related bear markets) drives other types of bond prices down.
The bear market aftermath can be brutal for Treasury bond investors and here is why. Since all but very short duration notes or bonds decrease in value when interest rates rise, those same Treasury bonds that were safe during the bear market will decrease in value once the financial picture improves since interest rates will be expected to rise. This includes Treasury bonds.
Lowering Investment Portfolio Cash
Experienced proactive investors who purchase undervalued assets after a bear market will naturally have a lower percentage of cash in their portfolio from selling stocks as they became more expensive .
Unfortunately, many investors tend to increase portfolio cash when assets are cheap after a bear market because investing feels scarier then.
And then investors lower portfolio cash when stocks are expensive from Fear of Missing Out (FOMA). It seems like stocks will continue going up forever in bull markets but they just won’t.
This is classic emotional investing from fear and greed. Logical investing based on numbers, data and history can help alleviate making investment decisions driven by fear or greed.
Ask me how I know? Been there and done that. First hand lessons are the best ones.
Summary for How Much Cash to Keep in Your Portfolio
Bull markets and bear markets are natural to stock market investing. Finding the best allocation of cash, stocks, and bonds is one of the most important elements of building wealth.
Investors who adjust the ratio of cash to investments in their portfolios based on valuations and trends can build wealth while lowering risk.