Topic: How To Invest

Understanding the Stock Market and your portfolio: How much cash should you hold

Investing for Beginners

Today’s market volatility makes some investors wonder how much cash they should hold.

I can think of three reasons why you might want to sell some stocks and hold cash now or at any time.

  1. You can’t sleep at night because you are nervous about the market outlook. In that case you should, as the saying goes, sell down to the sleeping point. This is less an issue of understanding the stock market and more about understanding your own risk tolerance.
  2. You expect you will need to take cash out of your portfolio in the next year or two and you don’t want to risk having to raise cash by selling stocks at low prices.
  3. You have some realistic reason to think stock prices will be substantially lower in, say, six months or a year. This is why most people take money out of their portfolio. Unfortunately they often get that pessimistic feeling at or near a market low.

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Numbers 1 and 2 are personal decisions. Number 3 is different.

Here’s how understanding the stock market and its role in your portfolio is key. Of course, at times you will guess right about a coming market downturn. But this urge to “go into cash” (as brokers refer to it) rarely appears at times that will pay off for you. All too often, investors give in to the urge to raise cash just when the market is near bottom. If you do that, you may wind up getting back in the market at higher prices. That can happen even if a downturn appears after you sell. After all, you won’t plunge back in the market just when prices hit bottom. You may instead sell more of your stocks.

I have to tell you that I know several investors who sold all their stocks within days of the March 9, 2009 market bottom. I tried talking them out of it and got nowhere.

Today’s low interest rates tone down a key risk factor, and I don’t see any reason for a huge upturn in rates. Low rates also minimize the return on T-bills and other cash-equivalent investments. So my view is that it doesn’t make a lot of sense to hold cash at this time.

If you currently have a large cash position, that doesn’t mean you need to rush or make snap judgments to get all your money into the market. Instead, take your time and weigh various investments to see which one is the best fit for the rest of your portfolio.

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