Here’s How Much Cash You Should Set Aside

“Nick, is it time to sell stocks and move into cash?”

I’m getting that question quite a bit lately. And it’s no wonder why…

The S&P 500 is down 9% since October, investor sentiment is low, and many people are seeing their retirement accounts dwindle.

When someone asks me whether it’s time to sell stocks, they’re usually asking if it’s time to sell all of their stocks for cash.

But that’s the wrong question to ask. Your choice isn’t binary (all in or all out).

There’s a place for cash in your portfolio, especially during periods of uncertainty like we’re experiencing now.

If you’re looking to sell some positions to raise money, I’ll tell you how much we suggest you allocate to cash… and how best to use that cash when the dust settles.

But first…

Cash Isn’t Risk-Free, Either

I once had a finance professor who said, “If you show me an investment with no risk, I’ll show you an investment with no return.”

For some reason that quote stuck with me… That’s because there’s no “risk-free” investment.

Now, cash is safer than most other investments. But holding cash still comes with risks…

The U.S. dollar can (and does) devalue relative to other currencies. And there’s always the risk that inflation will eat away at your cash savings.

On top of that, if you keep your cash at home, you could lose it to theft or in an accident. If your house is robbed or burns down, there goes your retirement.

So the idea that sitting on cash is riskless is a fairy tale. That being said, cash can stabilize your portfolio in volatile times.

If I’m nervous about the markets, I’ll sell a few positions to raise cash. That cash acts as a buffer against large downward moves in the market.

Let’s say you have a $100 portfolio, with $50 allocated to cash and $50 to stocks. If your stock portfolio goes down 10%, your stock position is now worth $45.

But your overall position is $95 ($50 in cash + $45 in stocks). So your portfolio has only lost 5%. And if your stock portfolio loses 20%, your overall portfolio only goes down 10%. So cash can ballast your wealth during a market pullback.

This is just hypothetical… But it demonstrates the power of asset allocation—the process by which you spread your wealth across different sorts of investments.

Palm Beach Research Group’s allocation model includes a broad array of assets—including gold, real estate, cryptocurrencies, and stock options. Since I’ve gotten a lot of questions about cash recently, we’ll focus on that today.

Cash Gives You Flexibility

In our asset allocation model, we generally recommend you keep 5–10% of your portfolio in cash.

At certain times, you can deviate from this allocation. For instance, if current market volatility is causing you to lose sleep, you can always allocate more cash than that.

That cash can come in handy… After a market decline, you can use it to purchase other assets when they’re on sale.

If you want to sit on the sidelines for a while, you can even earn some interest on your cash.

For example, you can make 2% in a short-term money market account or by purchasing three-month Treasury bonds. That’s the most you can earn through those instruments in nearly a decade.

Once the market settles down, you can use your cash to buy growth companies that have been beaten down and are selling at deep discounts.

One place to start is with companies that have achieved an earnings trifecta.

These are companies that have beat earnings and revenue guidance and raised forward guidance. History shows they drift higher until their next quarterly earnings reports.

The recent bout of volatility has dropped many of them back to the levels they were at prior to their earnings announcements. But once the market rebounds, they’ll sprint higher.

So if you’re worried about volatility, it’s fine to raise additional cash.

It will give you options. And you never know what opportunities life might throw at you. So keeping some cash on hand is always a wise decision.

But that doesn’t mean you should completely abandon stocks. When the tide turns, investors who hold onto their quality investments will make a lot of money.

Regards,

Nick Rokke
Analyst, The Palm Beach Daily

CHART WATCH

How Much Longer Will Market Volatility Last?

I’m sure many of you are wondering how long the stock market’s volatility will last.

My best prediction is that the market will remain volatile as long as the S&P 500 stays below its 200-day moving average (MA).

The 200-day MA is a good gauge of market health. If the S&P 500 is above its 200-day MA, that’s a strong sign. If it’s below that level, it’s a weak sign. And weak markets are always more volatile than strong ones.

As you can see in the chart below, the S&P 500 is below its 200-day MA.

As long as the market stays below the 200-day MA (which is at 2,760 right now), expect more volatility.

Nick Rokke

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Posted in Palm Beach Daily