It might seem like a good idea in periods of uncertainty because your account’s cash value is not impacted by market fluctuations, right? We know that over time, the amount you can buy with a dollar will be eroded, but for now, the cash account balance isn’t impacted by the market’s ever-changing mood. As I write this, the U.S. debt ceiling debate remains unresolved (something that may or may not change by the time you read this) the economy is moving along at a sluggish pace, and Europe is still dealing with its problems. There are all the reasons in the world to have an unfavorable and uncertain outlook. Yet this week, the Dow closed up over 150 points at over 12,700.
The problem with moving to cash when market conditions are unfavorable is knowing when to get back out of cash. One of the most common investing mistakes is moving into and getting out of cash too late, locking in big losses and missing out on big gains.
Over short periods, an allocation to cash is not a bad thing, especially if it accounts for a small portion of your portfolio. This is particularly the case if you sold a security or fund and are trying to decide where to reinvest the proceeds. Cash also makes sense if you know you are going to have an upcoming withdrawal from your account, such as a required minimum distribution (RMD) from an IRA. If there is a large expense that you expect to incur within the next couple of years, such as a new car, you should keep those funds in cash.
Consider all of your accounts contribute to your net worth, and anyone with a savings account already has an allocation to cash. Remember, the cash you’ve set aside equal to several months of expenses, unexpected events and emergencies, is already giving you some protection against the market’s volatility.
A key to portfolio risk is to find a balance between what allows you to sleep at night and what allows you to achieve your financial goals. If you want to protect your wealth against the eroding effects of inflation, you will need some exposure to stocks. Cash can provide short-term safety, but it won’t protect you against the dual threats of inflation and the risk of outliving your money.
Question: Do you tactically shift your portfolio into cash? If so, how do you determine when to move into and out of cash?