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Count the Cash

 Count the Cash

Jonathan Clements  |  November 16, 2019

When we think about portfolio building, we tend to think first about stocks. They’re our engine of investment growth—and the source of endless anxiety. Indeed, to make stock market investing palatable, we take all kinds of precautionary measures, including diversifying broadly, adding bonds, throwing in cash, purchasing gold and goodness knows what else.

But maybe we have this all wrong. Perhaps, instead, we should start with cash: how much we currently have in safe, liquid investments, how much we expect to receive in the years ahead and how much we’ll need in the near future. Once we have a handle on our cash situation, we’re free to invest the rest of our portfolio as we wish—including potentially stashing much or all of our money in stocks.

Sitting pretty. How much cash should we hold? In addition to a modest sum in our checking account to cover the next month’s bills, we should all hold some cash or cash-like investments, whether we’re in our 20s or our 80s. This money might sit in a savings account, certificates of deposit or a high-quality short-term bond fund.

Think of it as comfort cash. It can ease our worries, knowing we have a backstop if we have a surprisingly expensive month—and it can help us avoid the financial anxiety suffered by four out of 10 Americans, who apparently either couldn’t cover a $400 unexpected expense or, to do so, would need to borrow or sell possessions.

How much comfort cash should we keep? It’s partly about sleeping at night, but also partly about being prepared for financial emergencies. That’s an especially big issue for those in the workforce, because the big financial emergency is getting laid off.

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What about retirees? Because losing their job is no longer a risk, arguably they need little or no emergency money. But they may still need a heap of cash for another reason: to cover their spending needs in the years ahead.

Coming in. As a rule of thumb, money we’ll spend over the next five years should be out of stocks and riskier bonds. Instead, it should be invested in nothing more daring than a short-term bond fund. So how much cash do you need from your portfolio over the next five years?

For many folks, the answer will be zero—because they have enough cash coming in from elsewhere. If you’re in the workforce, your spending over the next five years will likely be more than covered by your paycheck, and thus there’s no need to hold anything more than comfort cash. Ditto for retirees who can cover their entire living costs with Social Security, plus any pension, annuity and rental income. For both these groups, investing heavily in stocks could make sense, provided they have the tenacity to stick with their holdings through the inevitable market turmoil.

The case for investing heavily in stocks is especially strong for those in their 20s and 30s, and not just because they have a long investment time horizon. A digression: There was a rather tedious debate in the 1990s about whether stock market returns are mean reverting.

If they are, periods of bad returns will be followed by stretches of good performance, and thus long-term stock investors with diversified portfolios should eventually get rewarded. But if markets aren’t mean reverting and instead performance is totally random, there’s no assurance stocks will deliver the highest return, no matter how long we hang on.

 

To continue reading, please go to the original article here:

https://humbledollar.com/2019/11/count-the-cash/

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