Balancing the scales on cash balances

Given current market conditions, investors are rightly reconsidering the strategic role of cash. As we’ve written before, investors are prone to over-allocating to cash. Cash is not an acceptable hedge against uncertainty, but there is a place for cash in a healthy asset allocation.

Why hold cash?

We put cash into three categories. Broadly speaking, each has its own purpose.

1. Working capital: This is your cash at its day job, paying bills and funding everyday spending. For most people, this cash lives in a checking account. Sources include employment income, passive rental income and pension distributions.
2. Reserve funds: This cash includes your emergency fund and any cash needed for known upcoming expenses, like a vacation or home remodel. Reserve funds may be held in a traditional savings account; they may also be held in a high-yield savings account or brokerage account, where there is greater potential for yield than in a traditional savings account.
3. Tactical, short-term holdings: Cash and cash equivalents accumulate naturally within brokerage accounts and should be reinvested in many, if not most, circumstances. However, there are times when cash is an essential part of short-term strategic positioning. Be sure to talk to your investment advisor about how they determine when holding onto cash is a smart move.

How much cash is too much?

Our advice is to keep a low target balance in your checking account to be used as working capital. Depending on your comfort level, two months of operating expenses will suffice. Excess cash can be sent to your investment account on a monthly or quarterly basis. The idea is to keep the least amount of cash possible in the lowest yielding environment for cash.

In terms of your ‘reserve funds,’ there is much more flexibility. This should include your emergency fund and cash for known upcoming major expenses.

• Your emergency fund is the cash you would only touch in extraordinary circumstances like the loss of a job or unexpected medical expenses. There is a lot of differing advice about the size of an emergency fund. Comfort level is again a huge factor here, and that’s why our recommendation is broad: An emergency fund should contain between six and twelve months worth of moderate monthly living expenses for a household. The key here is the word moderate. Your emergency fund doesn’t need to include months worth of your current monthly living expenses. Instead, it needs to hold months worth of your basic living expenses like mortgage payments, education expenses, and other non-negotiables.
• We also recommend that clients hold known expenses that are certain to occur in the next quarter as part of their ‘reserve funds.’  Longer-dated or uncertain expenses can be a part of the investments and liquidity discussion with your advisor.

Besides mostly fixed cash holdings like reserves and working capital, your investment account is where any additional cash should be housed. Cash is an asset class – by consolidating your strategic cash positions with the rest of your investments, you and your advisor will be able to more effectively allocate your assets and deploy your cash to suit your goals.

Tactical allocations to cash and cash equivalents can be a difficult thing to tackle for the retail investor, who may not have access to brokered certificates of deposit, commercial paper, repo agreements, or other instruments used by money market investors. In a low interest rate environment, the reach for yield can push investors into opaque pooled investment vehicles, which carry risks not immediately obvious to most.

Our point of view is investors should focus on pure, easily understood investments. Your cash position is no different.

To see what advice we can offer for your cash position, we invite you to schedule a consultation with an advisor at Jackson Square Capital,