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Should Cash Feature In Our Portfolios?

Most new investors already know that cash is one of the worst investments due to low savings interest rates and the effects of inflation on its buying power. Yet, there are still arguments that investors should hold a percentage of their portfolio in cash.

Before analysing the question of whether we should hold cash, I would first like to clarify that when I use the term “investment portfolio”, I am describing the stash of money that you have set aside for investment. This should exclude all living and emergency expenses that you may have in your savings.

In this regard, most individuals should, at least, keep six months to a year’s worth of expenses in cash as part of our emergency expenses. The remaining funds can then be allocated comfortably as your investment funds. This buffer is for cases of emergencies like loss of income or illness. With this allowance, investors can rest easy knowing that they would most likely not have to dip into their investment portfolio to tide them through.

Moving onto the big question of how much of our portfolio should we keep as cash. During my time learning from investment experts, I have found that there are, in fact, different points of view on this subject.

Why hold cash?

Many investors believe that holding onto some cash is vital as it gives them the option to buy new investments in the future, if the opportunity arises.

This is especially true for investors who believe that a market correction is on the horizon. They, therefore, prefer holding a good proportion of their investment portfolio in cash.

This may also apply to investors who cannot find good investments to put their cash into. If the market is trading at extremely high valuations, it may be difficult to find enough stocks or assets to put all your investments dollars into. Even mutual funds may at times hold a certain percentage of their portfolio in cash.

Why be fully invested?

On the opposite end of the debate, are the investors who want to be fully invested all the time.

These investors usually have no views on the near-term direction of the stock market and prefer to be invested due to overall long term upward nature of investments.

Cash is also one of the worst investments, as the purchasing power of cash decreases due to inflation. It also produces no yield (at the moment) or growth in any way except for the minimal bank interest you may earn on your savings account. Therefore, investors who are always fully invested, see cash as a drag on their overall investments returns.

The Foolish bottom line

It is important that new investors know the pros and cons of holding cash in our investment portfolio.

Having said that, there is, in fact, no hard and fast rule on the exact allocation of cash that you should hold. It, in fact, depends on a few factors such as current valuation of the stock market, the availability of good investments and your risk appetite.

Whichever strategy we choose, we need to be comfortable with our investment decisions so that we can sleep easy at night.

Meanwhile, for more (free!) investing insights, sign up here for your FREE subscription to The Motley Fool's investing newsletter, Take Stock Singapore. It will teach you how you can grow your wealth in the years ahead.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Jeremy Chia doesn't own shares in any companies mentioned.