Important Roles Cash Plays in a Portfolio

When you first hear the word “cash,” what may come to mind are the bills in your wallet. However, within the context of your overall investment portfolio, cash encompasses a much broader definition, including cash-equivalent securities.

Impact of interest rate hikes

From March 2022 through July 2023, the Federal Reserve raised interest rates 11 times, bringing the current fed funds interest rate to 5.25% – 5.50%─the highest in over 20 years. This higher rate environment can create more attractive opportunities in short-term cash equivalent securities that pay higher yields, such as high-yield savings accounts, money market deposit accounts (MMDAs) or certificates of deposit (CDs).

While earning a high interest rate on your cash can help your money grow faster, here are other roles cash plays in a portfolio:

• Liquidity – Cash provides immediate access to funds in case of unexpected expenses. Having cash on hand allows you to cover expenses without having to incur unwanted debt or sell investments at potentially unfavorable times. It is recommended that an individual have at least 3 to 6 months’ worth of living expenses in cash as an emergency fund.
• Flexibility – Cash allows you to quickly take advantage of investment opportunities such as buying stocks, bonds or mutual funds at lower prices during market downturns. By holding cash, you can rebalance your portfolio opportunistically.
• Diversification – Cash is considered a separate asset class with its own unique characteristics, such as low risk and high liquidity. By including cash in your portfolio, you can diversify across different asset classes to reduce overall risk and potentially enhance long-term returns.

How much cash is too much?

It may be tempting to allocate a large portion of cash to a CD or an MMDA now that interest rates are above 5%. Keep in mind that interest rates fluctuate and are expected to move lower. There is also the opportunity cost of missing out on potential higher investment returns historically offered by stocks. Cash may not generate sufficient returns to keep pace with inflation or help you achieve your long-term financial goals.

How much should you invest in cash?

Several factors—your current personal situation, risk tolerance, time horizon and short- and long-term financial goals—need to be considered when thinking about how much cash to set aside compared to other investment options.

Cash has its place in a diversified portfolio. However, make sure you are not missing out on the higher long-term returns that stocks and bonds typically provide. Speak with a Jemma Financial Advisor by calling 855.662.2121 or click here to determine the appropriate cash allocation that aligns with your overall investment strategy.