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Why holding cash should be a vital part of your investment strategy

by , 30 October 2015

It's easy to see why many investors don't like cash.

It earns poor returns in the bank. Putting your cash to work in investments means it's actually doing something for you.

But this shouldn't deter you from holding cash. In fact, it reduces your risk…


When it makes sense to hold cash


Holding cash instead of investing it makes perfect sense when stocks are expensive. When there seems to be limited upside potential in the market, you should stay in cash.

If you can’t find a fantastic investment opportunity, you should stay in cash.

There are three main benefits to holding cash…


Holding cash benefit #1: No market risk


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By holding cash, you don’t have any market risk. The value of your cash isn’t going to change.

If you’re holding large quantities of cash, just ensure you get more than inflation in the bank.


Holding cash benefit #2: No valuation risk


Valuation risk is the risk of paying more than an asset is worth or its true value, Dan Ferris in Daily Wealth explains.

If you end up paying too much for stocks, you face valuation risk. If this is the case, you’re better off in cash.

If valuations fall to levels you’re happy with and reflect the true value of a stock, then you can use your cash to invest.


Holding cash benefit #3: No fundamental risk


Fundamental risk is about the reduction of a business’ intrinsic value. This comes from investing in risky businesses that could fail.

The key here is that cash is a simple way for you to reduce risk in your portfolio. Of course, your returns won’t be great if you hold a lot of cash, but if the investment prospects aren’t great, it’s worth holding on until you find great undervalued companies to invest in.

So there you have it. Why holding cash should be a vital part of your investment strategy.

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