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Cash may underperform stocks and bonds, but you can use it to your advantage

by , 14 April 2015

Over the long-term, it's almost a certainty that cash will underperform stocks and bonds.

But that doesn't mean you shouldn't keep some cash.

You should have cash to cover emergencies and to use when opportunities arise in the stock and bond markets.

Read on to find out more…

How much spare cash should you hold?

For prudent financial planning reasons, it makes sense to hold enough cash to cover around six-months of expenses.

Unexpected costs and emergencies crop up. You don’t want to be in a position where you have to sell shares to cover these expenses, especially if the market is under strain, Alexander Green in Investment U explains.

And holding some extra in cash means if bargains present themselves on the stock market, you’re in a perfect position to take advantage.

How to use your cash to take advantage of market corrections

If the market undergoes a correction or enters a bear market, buying opportunities emerge for the savvy investor.

So if there is a market pullback, how should you put your cash to work?

You could follow an investment strategy like this…

  • If the market drops 20%, invest a third of your available cash.
  • If the market drops 30%, invest another third of your cash.
  • And if the market drops 50%, invest the remaining third. (Large drops like this only tend to happen a few times every 100 years.)

Using cash to invest in bonds

When interest rates go up, the prices of bonds fall. And if interest rates drop, bond prices rise.

With the chances of interest rates rising over the next few years, you could take advantage of cheaper bonds with higher yields.

So there you have it. How you can use cash to your advantage.

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Cash may underperform stocks and bonds, but you can use it to your advantage
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