Tucking It Away: How Much Cash Should Investors Allocate?

Warren Buffett is sitting on a ton of it. Apple has more of it than the U.S. and Canada combined. We’re talking, of course, about cash. And even though some people feel cash is often king, does it make sense to hold it in your portfolio?

Despite holding $90 billion in cash, “The Oracle of Omaha” has gone on record as saying he hates cash. Why? Because cash—especially in this extended low interest rate environment—doesn’t earn any return. And what meager interest it does earn can easily get eroded over time by inflation. Even worse, many financial advisors typically charge fees based upon your total portfolio value, including cash, which means you could theoretically lose money on the cash you hold in a managed account over the long run.

So how much, if any, cash should you hold? As with most financial questions, the answer isn’t straightforward, but there’s a good place to start.

Save for that Rainy Day First

Most experts agree that having an emergency cash fund set aside is important. If you’re still working, many experts recommend an emergency fund of three to six months’ salary. And if you’re retired, many financial advisors suggest having enough liquid funds to cover 12 months of living expenses. These funds can be held in a separate savings account or as a cash portion of your portfolio, but either way, this money should not be used for investing.

Once your emergency fund is set, you can determine how much extra cash to hold based upon your life stage and style of investing.

If you’re a passive investor, you might prefer to hold very little or no cash in your portfolio if your mix of assets is balanced and you have a long enough investing time frame. A well-diversified mix of asset classes—including cash equivalents—and strategies like quarterly rebalancing can help manage risk while making sure that most of your money is working for you at all times. This is especially true when you’re in your 20s and 30s, as you should have a long enough investment horizon to ride out the market’s ups and downs.

At different stages you might wish, you might wish to raise cash levels as needed in anticipation of stage-specific events like a home purchase or kids’ college tuition. Then, nearing retirement, when you might be more susceptible to short-term market gyrations, you can build your cash pile to suit your comfort level.

What About the Active Investor?

If you’re an active investor, holding a significant amount of cash might make sense, as you’ll always want to have some on hand to take advantage of market opportunities. That percentage will depend on how active you are, but there’s a strategy you can employ to have your money working as hard as it can, while still having some “dry powder” at the ready.

This involves periodically reviewing and selling parts of your portfolio that may no longer fit your current objectives, and in the process, freeing up cash that can be deployed in the future when opportunities arise. This can be done across asset classes as well.

In the end, there’s no right or wrong amount of cash to hold, and your decision about how much to keep in your portfolio may have more to do with your comfort levels than anything else. No matter what the “experts” may say, ultimately, a solid investment strategy should be implemented in a cool, calm, and non-emotional way. So one possible approach is to hold a level of cash that you are comfortable with.