These last couple of weeks have been wild ones for Wall Street, with the markets taking a nosedive and then staging comeback rallies before dipping again on coronavirus concerns. This kind of volatility tends to give investors whiplash, and can cause people to make knee-jerk reactions out of worry for a longer-term market slump.
Something that many investors start to explore or revisit during periods of volatility is the balance of cash vs. other investments in their portfolio and how they should be treating cash in an uncertain market and interest rate environment. It may be tempting to liquidate until things get more stable, but that’s often a bad idea that can have a negative long-term impact on your portfolio.
How to Think About Your Cash Position in a Volatile Market
Here are some things to consider about the balance of cash and investments in your portfolio during a volatile market:
1. Make Sure You Have an Adequate Emergency Fund
We generally recommend that most people should have an emergency fund covering three to six months expenses, but this number might vary depending on your age, time horizon, and other factors.
Holding the right amount in cash is extremely important — you don’t want to be forced to sell stocks in a down market to finance your day-to-day living expenses. Making a sale during a severe correction or a market pullback is one of the most damaging things you can do to your portfolio, so make sure you have enough cash to cover living expenses so you don’t have to tap your portfolio at inopportune times.
Setting aside cash in advance of any market movements is especially important for retirees, as it gives them control over their cash flow and protects them from having to raise cash during a downturn because they’re short on funds. For retirees, making a sale during a down market is particularly damaging.
2. If You Are Holding Extra Cash During Volatile Markets, Make Sure It Isn’t Idle
If you are holding a little extra cash during uncertain markets, holding it in a high-yield account ensures that it isn’t sitting idle and earning a fraction of a percent in interest. These accounts are FDIC insured, pay much higher returns than traditional savings accounts and allow for complete flexibility. Personal Capital recently launched Personal Capital Cash which offers unlimited monthly transactions. For investors with a little longer timeline, short-term U.S. Treasuries, certificates of deposit (CDs) or short-term bonds may also provide an interim solution.
3. Resist the urge to liquidate or heavily reduce equity positions.
Keep in mind that market drawdowns are a natural part of the economic cycle. While these uncertainties can cause anxiety, moving to cash is primarily a defensive move that makes sense for needs with a relatively short timeframe, but a balanced amount of equity risk is still required to meet long-term needs.
How much you should have in cash is a very personal question, and while the above tips can help you ponder what your mix should be, consulting with a financial advisor is the best way to get an objective opinion on your portfolio. So instead of worrying about the next market pullback, we recommend that investors take the time to examine their overall investment portfolio and cash positions. Instead of making knee-jerk reactions when the market wobbles, make appropriate shifts based on personal circumstances, accounting for short-term requirements as well as long-term goals.
If you’re worried about the market’s ups and downs, read our FREE Guide to Market Volatility.