How much cash should I have in my portfolio?
Determining the right cash level for your portfolio is a common question, and the answer varies depending on your unique circumstances and current market conditions.
Some factors that help to determine how much to hold in cash and cash equivalents include:
- Your financial goals and objectives
- Your time horizon for investing
- Your spending needs
- Your risk tolerance
A general rule of thumb is that cash or cash equivalents should range from 2% to 10% of your portfolio, although this will vary from person to person.
One situation where extra cash may make more sense is if you’re planning on a big purchase or expense within the next few years, such as buying a home, paying for college tuition or undergoing a major home renovation. In those circumstances, it makes sense to set aside cash a year or two in advance of incurring those costs.
On the other hand, some people might maintain a lower cash position based on their leverage opportunities.
In a low-interest rate environment, for example, you might have equity built up in your home that you can tap into, such as through a home equity line of credit, versus holding extra cash. The current environment’s higher interest rates have made this option, at least for many, less attractive.
Income and net worth are two additional considerations. For example, if you have a steady income and can count on liquidity from a paycheck or annual bonus, a smaller cash position may be appropriate.
If you work as an independent contractor or have a job where your income stream varies, keeping more in cash reserves may be prudent. This can help protect against an unexpected income shortfall or unanticipated expense.
Cash and cash equivalents: Finding a balance
It’s often challenging to find the right balance of cash and cash equivalent holdings. Investors sometimes mistakenly carry too much or too little cash for their situation, or they fail to invest cash in a way that earns a competitive yield.
For example, 2022’s market volatility, during which both stocks and bonds suffered significant declines, coupled with the allure of higher interest rates, led some investors to shift money out of stocks and bonds into cash. While it may have seemed like an attractive short-term option, it might have had negative long-term portfolio consequences.