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The critical role of cash in your investment portfolio

For a valuation-conscious investment strategy, cash equivalents in the portfolio in times of overvaluation can act as ‘dry powder’

August 31, 2020 / 08:56 AM IST

Dev Ashish

Nobody wants to discuss about cash in the portfolio when markets are rising like there is no tomorrow. But, in fact, it is the opportune time to have such a discussion.

But before we discuss the role of cash in your investment portfolio, please make a note of the following two points.

-This is not a post about cash and cash equivalent products (mostly debt instruments) earmarked as part of your emergency fund. We talk about the investment portfolio here, which should never be treated as part of your emergency reserves.

-Since we are discussing cash and related aspects, it’s obvious that you are someone looking to manage your investment portfolio allocation actively. And a majority of you would (no doubt) want very high returns from your investments. Who doesn’t? But no matter what you are told, high returns alone will not be enough for you or your goals. Unless you consciously work towards bringing your basic personal finances in order, any efforts to try and optimize the riskier investment portfolio will not help you reach anywhere.

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Strategy with cash

When it comes to investment, any strategy worth its salt will look at growing your money judiciously while trying to limit the losses as much as possible. Since no strategy works all the time, and no one is a perfect market timer, it’s never about being only 100 per cent or only zero per cent in equity. It is not that binary. Right? So your long-term investment portfolio will have equity and debt/cash in varying proportions. Let’s ignore gold for the sake of simplicity.

A good strategy will try to actively adjust your allocation between the two on the basis of various factors. In a simple way, on the basis of the time available at hand, opportunities that can be participated in, tactical stances of the portfolio strategy and most importantly, the risk appetite of the investor must be decided.

Now, cash is a terrible long-term investment. In fact, it’s wrong to even call it an investment here. But without doubt, cash brings short-term options on to the table which, if used smartly, help add to your long-term returns. It is not easy, but nevertheless can be done. Smart investors do it all the time. But this does require knowledge, skill and patience to wait for the right opportunities – not everyone’s cup of tea. As I said earlier, anyone can be a DIY investor but not everyone. So, if you are not sure if you can do it, talk to a good advisor.

The problem with cash is that if you keep waiting for certain opportunities for very long, it will be a drag on the returns as any cash allocation will have a long-term opportunity cost. So you must be very careful with it.

Saving dry powder

For a valuation-conscious investment strategy, cash equivalents in the portfolio in times of overvaluation can act as ‘dry powder’. So not only does it protect from the future expected downturns, but also positions the portfolio appropriately (to buy more equities) when markets correct and attractive investment opportunities present themselves.

Cash can also be a position in your portfolio. It’s not that passive a component as people think it is.

As I said earlier, cash isn’t discussed much when talking about investment strategies. But it should be. ‘Cash is king,’ it is often said. At least in investment strategies, it can be one occasionally if not frequently.

If the investor has to wait for extended periods of time, cash should be held in suitable debt instruments, as these offer similar liquidity benefits but with potentially higher returns. This, of course, comes with some interest rate and credit risks. But these can be managed well if expectations from debt funds are correct to begin with.


(The writer is the founder of StableInvestor.com)

first published: Aug 31, 2020 08:56 am

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