Why you need cash
- 3 min reading time
Keeping cash in your portfolio not only lets you take advantage of buying opportunities, but also helps to limit losses when stock markets are volatile.
What you will learn
Investors are often criticised for having too high a proportion of cash in their portfolio, but a small amount can be very useful.
Money held as cash doesn’t need to be sold in order to be used. That means you can buy something else with it extremely quickly and without its value being affected. This makes cash invaluable when it comes to paying emergency bills or taking advantage of investment opportunities.
The downside of cash is that it offers little potential for growth, even if it is held in a savings account. When interest rates are low, cash can gradually lose value over time.
Did you know?
Inflation can undermine the value of cash savings in a low-interest-rate environment, as the price of goods increases faster than the rate at which your savings grow in value.
The question is how much cash should you hold in your portfolio? The exact proportion will depend on factors such as your age, the length of time you plan to invest for and your personal financial goals. One useful rule of thumb for investors is to hold the equivalent of up to six months of living expenses in cash. Beyond that, it makes sense to invest in other asset classes.
Using cash to invest
When you see an attractive investment, the last thing you want is to have to wait days, or even weeks, to buy it. Having cash in your portfolio means you can buy the stock or fund almost immediately.
Compare this to an asset such as property, which you would have to sell to access your money. Depending on the market conditions, a property sale can take time. If you need to sell quickly, you might have to accept a lower sale price.
Shares in stock market-listed companies are more easily turned into cash as they can be sold quickly on an exchange at a price within a few pennies of their market value. It does, however, depend on the type of company as shares in some AIM (Alternative Investment Market) companies can be harder to sell than shares in FTSE 100 companies.
Selling one asset to buy another can also result in unnecessary transaction fees. You’ll have to pay two lots of dealing fees – both selling and buying – instead of just one.
Your buffer against market shocks
Cash acts as a buffer for your portfolio. If you have invested solely in equities (shares), you’ll be more affected by any dip in the market than if you have diversified across equities, bonds and cash.
In general, someone who has less time to invest their money – say, because they want to retire in three years – should focus more on cash than someone who is saving for their retirement in 40 years’ time.
This is because the shorter your available timeframe, the less likely you’ll be able to recover from sudden market downturns.
Having access to cash also avoids the need to sell stocks or bonds in an emergency and lets you take advantage of buying opportunities. To find out more about how to blend cash with other assets, read our guide to asset allocation here.
Any information provided should not be considered personal advice. Past performance is not a guide to future performance. You may not get back the full amount you invest. If you have any doubts about making your own investment decisions, seek financial advice.