With yields on cash instruments at rock bottom levels, holding more cash may seem like a counterintuitive strategy, but it actually has some merit.
“Similarly, a cash allocation in portfolios can be thought of as dollars not being used to secure an available investable asset,” according to BlackRock research. “And at first, having any cash allocation at all can seem a bit naive today. With interest rates at 0%, cash offers no return, and could even be considered a liability with a negative return if assessed either against the opportunity cost of owning an asset with positive return potential (FOMO in urban speak), or relative to inflation (via a negative real return).”
Prior to recent weakness, capital markets once again had the risk dial turned up with investors exiting their cash positions. Covid-19 certainly sparked a lot of that movement to cash via short duration Treasury ETFs as a safe haven move, but, despite the recent drop, more capital flows into equities could continue.
Why You Should Consider Cash
As many fixed income investors already know, yields on U.S. government debt are anemic and the shorter duration investors take on, the lower those yields.
“Yet the game of chess shows us that there are reasons why declining to take a particular position today may actually offer better long-term prospects for portfolios, and a higher probability of winning the long game,” adds BlackRock. “Some opportunities, whether in very low yielding high quality fixed income, or in structurally challenged industries, offer simply too small of a return to warrant the risk, and could result in constrained overall portfolio positions down the line that preclude new risk from being taken. Against such slim opportunities, it may be better to hold cash instead and focus on developing other parts of the portfolio.”
With the way the stock market has been fluctuating up and down as of late, investors who can’t stand the high level of volatility are probably parking their capital in the cash lot. With the Federal Reserve slashing interest rates to zero percent, cash might be king.
“There is no magic formula for how much cash a portfolio should hold. As a defensive strategy, the answer to that question would be largely dependent on what the rest of the portfolio is made up of. The higher the return potential of other assets in the portfolio, the more a portfolio can afford a cash allocation (keeping in mind that while cash has a 0% return, it also has 0% volatility),” concludes BlackRock.
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