The Confidence Paradox: Cash Management in Roaring Markets
Investors often grapple with the question of how much cash they should hold in their portfolios.
On one hand, keeping a sizable cash position seems counterproductive—cash earns next to nothing (or so it appears), and it can drag down overall portfolio performance.
On the other hand, some investors deliberately hold significant amounts of cash for years, waiting for opportunities that may or may not materialize in the near term. Depending on how large that cash position is, it can be a significant drag on the overall portfolio performance, a drag that is almost impossible to overcome.
Consider an investor who places half of his portfolio in equities ($10,000) and half in cash ($10,000), with the equity portion compounding at an impressive market-beating 15% annually and the cash earning a return of 0%, effectively losing purchasing power.
After 10 years, the equities (initially 50% of the portfolio) would grow by a factor of about 4x, so our initial $10,000 investment becomes $40,456 after ten years. The other half ($10,000) doesn’t grow at all, meaning the overall portfolio grew from $20,000 to $50,456 after ten years, a CAGR of “only” 9.7%—depending on the market environment the impressive 15% CAGR resulting from the individuals stock-picking skills may or may not result in market outperformance.
This example highlights the delicate balance investors often struggle with:
Cash can feel like dead weight… until it’s not.
In this post, I’ll explore why having an appropriate allocation to cash can be more valuable than it might initially seem, especially during periods of market euphoria.
I’ll discuss the concept of “option value,” examine lessons from high-profile investors, and debate whether maintaining some cash for future opportunities can be a powerful strategy.
Disclaimer: Investing is a counterintuitive discipline. While I highlight the value of cash in this blog post, and while I’ve highlighted in previous posts that I believe the market is due for a correction, I myself am fully invested right now.
