How Much Cash Should You Hold?

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tdp2664 InvestorPlace As you might imagine, I receive a lot of questions from readers around the world, and right now the question I’m being asked most frequently is “How much cash should I be holding?” There’s no right answer, but given the extraordinary times we’re living in, I think the more interesting thing to consider is “What should I do with it?” But first things first. Let’s talk about how much cash might be appropriate, then address what to do with it. Traditional Wall Street thinking holds that cash is a drag that actually holds you back. The argument — particularly in a low-interest-rate environment — is that cash actually produces a negative real return because it really isn’t “earning” anything while it burns a hole in your pocket and gradually loses ground to inflation. I have a problem with this argument in that it’s based primarily on the assumption that there’s nothing better down the road. I believe cash is key when it comes to providing the flexibility needed to safeguard wealth or capitalize on new opportunities — even now. Not to make light of the current situation in Europe or our woes here in the United States, but the way I see things, you can either ignore the problems and hope they go away (in which case your cash is a dead asset), or you can learn how to deal with the uncertainty and profit from it (in which case your cash is an asset). If you’re retired, holding something on the order of two to five years of living expenses is prudent. That way you can plan for regular expenses like insurance, medical bills, a mortgage if you’ve got one and investing — especially investing. Now, if you’re still working and have a regular paycheck, you can take some risks and hold less cash on the assumption that future income will offset the risks associated with a lower cash “buffer” on hand. A generally accepted rule is six months, but I think given today’s economy, 12 months’ worth of expenses is more appropriate. Either way, the goal is the same — to have enough cash on hand that you don’t have to spend money you don’t want to at an inopportune time, nor sell something when you don’t want to. For somebody in my situation, I think having about 20% of my investable assets in cash is about right. If that strikes you as low in today’s markets with all the risks they harbor, bear in mind I also use trailing stops religiously and I’m prepared to go to cash if things roll over. If you aren’t disciplined or aren’t prepared to be as nimble as the markets require, perhaps a more conservative 40% to 60% is appropriate. Maybe more. Once you’ve decided what level of cash is appropriate for your particular situation, you can get to the bigger question of what to actually do with it. This is where things get really interesting because even cash can be tweaked for better performance.