What’s the right amount of cash in your portfolio?

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Is there a benefit to holding cash in portfolios? Here, strategists from Wells Fargo Investment Institute explain the role cash can play in investments.

The right amount of cash doesn’t have to do with the cash in your wallet. The questions and answers below, provided by the strategists at Wells Fargo Investment Institute, can help investors know when cash may be an option—and when it may be too much.

For investors, cash is shorthand for assets that you can access quickly to cover an expense, so you don’t draw from other savings. Cash assets are useful in an emergency (such as a job loss) so you don’t need to tap into a retirement plan like a 401(k) or an IRA.

Types of cash assets:

  • Short-term Treasury bills
  • Money market mutual funds
  • FDIC-insured checking and savings accounts

What cash assets have in common:

  • They typically have lower downside participation and may offer lower potential return than other investments.
  • They’re liquid and easy to access.
  • They’re not intended as a primary long-term investment.

Investments may have less chance to grow when they’re held as cash, say the strategists at Wells Fargo Investment Institute. And in the long run, cash doesn’t help preserve purchasing power. Inflation, as represented by the Consumer Price Index (CPI) for example, can erode the purchasing power of cash.

  • When you sell a house or inherit some money you may need a little time to figure out where to invest.
  • When you’re planning for a big expense within a year or two, such as college tuition payment or a house purchase, you may want to have cash available.
  • When you’re faced with an emergency, such as a job loss or a natural disaster, cash may be useful.

The strategists at Wells Fargo Investment Institute recommend considering an amount equal to three to six months of salary as an emergency fund, although that can vary. Consider these questions when deciding how much cash to hold in an emergency fund:

  • Are you a single earner or part of a two-earner couple?
  • How secure is your job?
  • Are you retired?
  • How comprehensive is your medical plan?
  • Are you prepared for a natural disaster that may damage your house or car?

*Source: Wells Fargo Investment Institute

Wells Fargo Investment Institute strategists recommend investing it in equal amounts over a period of several months.

That way:

  • It may be less likely that all cash is invested at peak prices.
  • Cash will buy more shares when prices are lower.
  • Cash will buy fewer shares when prices are higher.
  • Portfolios may be biased toward lower-priced shares by using this strategy.

This strategy is called “dollar-cost averaging,” which can take advantage of market volatility.

A periodic investment plan such as dollar cost averaging does not assure a profit or protect against a loss in declining markets. Since such a strategy involves continuous investment, the investor should consider his or her ability to continue purchases through periods of low price levels.

  • Strategists at Wells Fargo Investment Institute say that cash has important uses but should not be a primary, long-term investment for most investors.
  • In most portfolios, cash should be only a small share of the whole portfolio.
  • Investors tend to hold more cash than investment professionals suggest.

 

This information is provided for educational and illustrative purposes only.

Diversification and dollar cost averaging are investment methods used to help manage risk. They do not guarantee investment returns or eliminate risk of loss in a declining market.

All investments are subject to market risk which means their value may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors due to numerous factors some of which may be unpredictable.

An investment in money market mutual funds is neither insured nor guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of your investment at one dollar per share, it is possible to lose money by investing in the fund. Bank products offer fixed or variable rates. Principal is fixed and may be insured. Withdrawals prior to maturity may be subject to penalties.

Opinions represent WFII’s opinion and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. WFII does not undertake to advise you of any change in its opinions or the information contained within. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability or best interest analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. The material contained herein has been prepared from sources and data we believe to be reliable but we make no guarantee to its accuracy or completeness.

Wells Fargo Investment Institute, Inc. (WFII), is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, NA., a bank affiliate of Wells Fargo & Company.