How much cash is too much cash?

[MrFoolish]

I suppose it's semantics but I wouldn't call cash a "hedge" at the moment. I'd call it a way of losing around 8% purchasing power pa. But each to their own.

But that’s just not true. Why do people not understand inflation? All that matters to me with regard to my cash holdings is my own personal inflation rate, which is governed by which products I decide to buy and which services I choose to use. A lot of that expenditure is discretionary. I’m sorry, but the idea that anyone’s expenditure exactly matches a random basket of 700 items selected by the ONS is a nonsense.

Bit of a strawman point. I'm well aware that everyone makes their own purchasing choices, but I can hardly adjust the official figure to accommodate some unknown person on this forum, now can I?

[simoan]

I suppose it's semantics but I wouldn't call cash a "hedge" at the moment. I'd call it a way of losing around 8% purchasing power pa. But each to their own.

But that’s just not true. Why do people not understand inflation? All that matters to me with regard to my cash holdings is my own personal inflation rate, which is governed by which products I decide to buy and which services I choose to use. A lot of that expenditure is discretionary. I’m sorry, but the idea that anyone’s expenditure exactly matches a random basket of 700 items selected by the ONS is a nonsense.

Bit of a strawman point. I'm well aware that everyone makes their own purchasing choices, but I can hardly adjust the official figure to accommodate some unknown person on this forum, now can I?

It’s not a straw man at all, it’s financial reality. Why pay any attention to a number based on prices of 700 items, 650 of which I do not buy, let alone buy them year after year. Just because CPI can be calculated does not make it useful or meaningful at a personal level.

[absolutezero]

Hi AbsoluteZero.

According to my model, if you were born in early 1982, 66% equities is about right. However, that's a trite answer and without context.

To expand a little, some recent reading I've been doing suggests 78% equities is optimal if you wish to maximise return, 29% equities is optimal if you want to target Sharpe Ratio (roughly, minimise excess risk) and that particular author's suggestion of a reasonable compromise is 48% equities. I'm sure there are other views.

For purposes of discussion, let's say that author's data is broadly accurate. I have then extrapolated that to the conclusion that I wanted to be 78% equities at birth and be 48% equities if I live to 100 then die. I am now, for all four family members, planning to traverse that spectrum linearly by age (hence the 1982 bit).

The problem is there are many degrees of freedom - e.g. what are you investing in other than equities, do you have a house and have you paid it off, etc. Strictly speaking, the above assumes the balance is in bonds and that there is minimal cash being held. I am personally combining bonds and cash in that second category - and simply using the equity ratio as the proverbial North Star.

As a practical matter, for Mrs Newroad and I, we put £1K a month into an NS&I rainy day account and the rest we are "running down" into equities (and where relevant, bonds - see later) until we hit the age suggested ratio - at which point we'll maintain it.

The big thing I missed until I took a truly holistic view is how much cash we held - I originally only monitored investments (and we've paid off our house). The other thing is final salary pensions, if any - I truly can't think of a sensible way to factor them in. Logically, they seem to fit close to the cash/bond pool, but for purposes of simplicity, I am currently choosing to ignore them completely (and similarly, the house, which seems more equity-like to me, or an "alternative" investment if you were considering that as a category). So, our situation is actually

Net Position = House + Nominal Final Salary Pension + Investments

where

Investments = Equities + Bonds/Cash

with the Equity Ratio targeted, the Cash drip fed as described above and the Bonds picking up whatever slack is left.

Whether that is useful at all - or helpful to you specfically - I don't know. I hope it is!

Regards, Newroad

PS To answer your question about cash, it is

1. To live with in an emergency, and
2. To provide optionality if other asset prices fall

I hadn't actually thought of the final salary pension - which has bond-like qualities.
That's worth around £8,500 (index linked) at the age of 60 - though whether that will ever happen is a different matter!

What's the logic behind 78% equities?

[absolutezero]

As others have said, there is no general answer to your question.

I regard 6 months worth of cash as sufficient. Others would strongly disagree with my position.
Were I a Freelancer, I too might wish for a bigger cash float.

I'm a fan of equity investment and have been doing it long enough that I know how I react to crashes. I also can expect a full* state pension relatively soon and a modest DB pension even earlier. My situation is nothing like yours and what works for me might well be wrong for you.

That said I do strongly recommend that you consider diversifying the "cash" part of your portfolio. You don't say, but imply, that 25% of your wealth is tied to the UK currency. Have you considered diversifying via things like international bond funds, gold or a capital preservation investment trust or fund?

As suggested, I don't like "cash". However some of my holdings are, a bond fund, HFEL (IT that invests in Asian banks and bonds) and RICA (Ruffer IT). Ruffer have in the past raised eyebrows by investing in Bitcoin as a low risk asset! They no longer own any, but do have an huge position in "cash" like investments. Ie international index linked bonds, gold and various currencies. Their past performance has been "boring". That is to say no stunning growth, but no significant falls. NO not even due to Covid or recent war like events.

*I hope that it's obvious, but check that you are paying the right stamp to get your state pension eventually.

All good points.
I pay my voluntary NI of around £3.50 a week (my employment affairs are designed to be tax efficient). Though whether the state pension will exist in 25 years is a different matter! (I suspect not or heavy means testing)

[absolutezero]

I am waiting with cash to invest, probably wrongly, for a significant market correction.

But what does it take ? Major European War (with open discussion of actually using the ultimate deterrent ), UK CPI Inflation possibly 10% (RPI 14% ?) towards year end, potential civil unrest when energy bills hit front door mats.

I mean, what does it take ??

Today, the gold market seems to think that all is solved, curiouser and curiouser.

Does the Fed have investors' backs? That's the key question.

[absolutezero]

I think that, as a freelancer, at least a year's normal expenses would be a minimum to see you over any blank periods. Here I am talking about cash deposits, apart from index-linked NS&I and premium bonds. They give you a further cushion. Apart from those you should be 100% in equities.

Presumably all those will be in tax shelters, either a SIPP and/or an ISA. I would ignore suggestions about trying to time the market, but keep on investing regularly, regardless of the state of the market. My experience over 50 years has been that staying fully invested is the best way to go. You may have to take action from time to time with odd shares that misbehave, but normally you can just carry on reinvesting dividends in the most appropriate places.

Hope that comment helps.

TJH

Thanks, Terry.
I'm slowly moving the unsheltered stuff into ISAs and SIPPs by selling outside and re-buying inside the tax shelter.
Probably take about 5 years.

Part of me is thinking longer term, what happens next week/month/year is irrelevant - except for some Communist takeover of the UK that we almost had in 2017 - I'm fairly sanguine about the markets...

[scrumpyjack]

It is a mistake to talk about equities as if they are all the same. Shares in a company can be thought of as a ‘wrapper’. The riskiness or otherwise will vary hugely based on what that company does or has its assets invested in. It could put it all in cash!

Cash is guaranteed to lose value, as other posters have pointed out, so I have always been 100% equities, until I retired when no more earned income could be relied on and I started to keep a cash buffer. The important point for me is what range of real assets do you put your money in.

I have never ever touched gilts/bonds apart from holding Index Linked Gilts for a few years, at the time you could actually get a positive real return from them, which you can't do now.

[absolutezero]

You are a serious professional.

Serious professional?
That's an amusing one! I'm just busking it (like everyone else - whether they realise it or not).

What are you envisaging that requires that much firepower?
Flexibility is different, but I don't think that is what you are asking.

As I say, I have a very particular perspective, very distinct from the trend here so I will not be at all ofended if this is so other worldly as to be a waste of everyones time.

W.

That's part of my question. What is cash for?
Why am I holding so much of it?
If TSHTF and work dried up then I could just sell some of my shares - or get a 'proper job' as my Dad calls it.
Or am I holding it as dry powder for a market correction that may never come?

[absolutezero]

It depends how you view cash within your investment accounts... If you are desperate to invest in equities just because you are worried about inflation eating your cash then you're starting from a pretty bad place psychologically IMHO. When it comes to investing, you should never feel any kind of desperation to "do something" whether it's worrying about inflation or FOMO in a rising equity market.

But is that nagging doubt about inflation a sign that I am holding too much cash?

[absolutezero]

It is a mistake to talk about equities as if they are all the same. Shares in a company can be thought of as a ‘wrapper’. The riskiness or otherwise will vary hugely based on what that company does or has its assets invested in. It could put it all in cash!

Cash is guaranteed to lose value, as other posters have pointed out, so I have always been 100% equities, until I retired when no more earned income could be relied on and I started to keep a cash buffer. The important point for me is what range of real assets do you put your money in.

I have never ever touched gilts/bonds apart from holding Index Linked Gilts for a few years, at the time you could actually get a positive real return from them, which you can't do now.

My suspicion is bonds are not worth the paper they are printed on and are going to get hammered.

[scotview]

Does the Fed have investors' backs? That's the key question.

Ah yes, the Fed.

I am a regular Bloomberg viewer. USA or European financial commentators generally use the "Fed" word by their second sentence. Fed, Fed, Fed, Fed......

The Fed is covering the whole world's financial system (apart from maybe the likes of the dourly thrifty Norwegians), I find it quite scary and it's all covered by a paper greenback being churned out of a printing press.

But maybe I'm totally wrong, certainly have been up to now.

[Newroad]

Hi AbsoluteZero.

You would need to read pp78-81 or so (and perhaps others) of Carver's book to get the full picture, but in short, going higher than 78% equities seems not to increase the upside but increases the downside.

To give one example cited (US stocks and bonds since 1928) the book notes

"Take for example the all equity portfolio. It has the highest average geometric return (3.1%) but 5% of the time it's average return over 20 years is worse than -4.47%. The expected probability of losing money if you hold an all equity portfolio over 20 years is around a quarter."

If you were to look at historic returns and do a Monte Carlo simulation or something like that, I'm sure you'll be able to see the effect of the significant falls that occur once in a while and both the risk mitigation and optionality that bonds would provide in that scenario.

Regards, Newroad

PS I don't think the Fed has investors' backs at present - feels closer to a new Volcker era to me.

[absolutezero]

Does the Fed have investors' backs? That's the key question.

Ah yes, the Fed.

I am a regular Bloomberg viewer. USA or European financial commentators generally use the "Fed" word by their second sentence. Fed, Fed, Fed, Fed......

The Fed is covering the whole world's financial system (apart from maybe the likes of the dourly thrifty Norwegians), I find it quite scary and it's all covered by a paper greenback being churned out of a printing press.

But maybe I'm totally wrong, certainly have been up to now.

As long as money printer go brrr then S&P will (probably!) go up.

[vand]

If its cash that's required for your emergency fund/living expenses buffer then whatever you feel helps sleep at night.. although imo 6 months' of basic living expenses is too getting towards too much.

If it's money that's earmarked for investment then I think anything above a very small amount (let's say 5%) is a red flag that you need to revisit the basics of asset allocation 101. IMO questions of risk, asset allocation, cash and market timing are all getting at the same thing. People who ask how much cash they should hold would be better served by asking what is a comfortable risk tolerance and choosing an asset allocation that fits in with that.

That doesn't mean that you can't adjust your asset allocation in response to how you percieve forward looking risk vs reward, which may in turn be influenced by current valuations.

[simoan]

It depends how you view cash within your investment accounts... If you are desperate to invest in equities just because you are worried about inflation eating your cash then you're starting from a pretty bad place psychologically IMHO. When it comes to investing, you should never feel any kind of desperation to "do something" whether it's worrying about inflation or FOMO in a rising equity market.

But is that nagging doubt about inflation a sign that I am holding too much cash?

It is just my opinion, but I believe you’re holding too much cash regardless of inflation given your circumstances. What you have to remember is that equities suffer from inflation too which reduces their profitability and generally causes share price declines, particularly where it leads to a recession. It’s not a zero sum game.

[Itsallaguess]

I suppose it's semantics but I wouldn't call cash a "hedge" at the moment. I'd call it a way of losing around 8% purchasing power pa. But each to their own.

But that’s just not true. Why do people not understand inflation? All that matters to me with regard to my cash holdings is my own personal inflation rate, which is governed by which products I decide to buy and which services I choose to use.

A lot of that expenditure is discretionary. I’m sorry, but the idea that anyone’s expenditure exactly matches a random basket of 700 items selected by the ONS is a nonsense.

Isn't the bulk of current inflation coming from food and energy though Si?

You're not an eskimo by any chance are you? :O)

I take your point that a single inflationary figure will never 100% align with any one particular persons spending habits, but I don't think anyone's really claiming that to be the case, and where current inflationary pressures are primarily being driven by food and energy costs, how much 'discretion' does anyone really have in avoiding, if not all of the inflation that might be about at the current time, then at least a big ugly chunk of it?

Isn't it sensible to broadly agree that almost everyone will see a level of inflationary pressure going forward, in at least the short to medium term, that we've not experienced for many, many years?

Yes, it might not be bang on 8% for someone, but it's not likely to be 1% or 2% in the current climate either, is it?

I should add that I myself usually do carry a level of cash that others here might think to be very over-cautious, and that I do agree with you that it's a mistake to consider the risk of inflationary loss on such cash as taking too high a priority over any potential reasoning for not doing so, and I agree that it does help to act as a dampener on volatility, and also sometimes acts as a fund to dip into when looking to take advantage of relatively dramatic market-movements, so I'm certainly not one to argue against holding cash, but it just felt odd to see what looked like someone thinking they were perhaps immune to what are largely energy and food-led inflationary pressures, that's all...

Cheers,

Itsallaguess

[simoan]

Isn't the bulk of current inflation coming from food and energy though Si?

You're not an eskimo by any chance are you? :O)

I take your point that a single inflationary figure will never 100% align with any one particular persons spending habits, but I don't think anyone's really claiming that to be the case, and where current inflationary pressures are primarily being driven by food and energy costs, how much 'discretion' does anyone really have in avoiding, if not all of the inflation that might be about at the current time, then at least a big ugly chunk of it?

Isn't it sensible to broadly agree that almost everyone will see a level of inflationary pressure going forward, in at least the short to medium term, that we've not experienced for many, many years?

Yes, it might not be bang on 8% for someone, but it's not likely to be 1% or 2% in the current climate either, is it?

I should add that I myself usually do carry a level of cash that others here might think to be very over-cautious, and that I do agree with you that it's a mistake to consider the risk of inflationary loss on such cash as taking too high a priority over any potential reasoning for not doing so, and I agree that it does help to act as a dampener on volatility, and also sometimes acts as a fund to dip into when looking to take advantage of relatively dramatic market-movements, so I'm certainly not one to argue against holding cash, but it just felt odd to see what looked like someone thinking they were perhaps immune to what are largely energy and food-led inflationary pressures, that's all...

Cheers,

Itsallaguess

That’s not what I was meaning at all and you are twisting what I wrote. Of course there is higher inflation now due to the cost of energy but that’s just one factor out of 700 used by the ONS to arrive at a supposed universal inflation rate. That number does not represent my expenditure which is far less than it was this time last year. And I am afraid some people do not get that point.

There has always been inflation - in more normal times CPI is 2-3% and even that low level silently eats away at cash holdings with the very low interest rates available. So why reduce cash and invest it in equities now? The timing seems very odd with regard to the OP from a risk perspective when we’re may be heading towards a global recession.

Anyway I have no wish to get involved in discussions that stray too far from the subject of the OP. In particular I have no interest in discussing economics.

[1nvest]

I should add that I myself usually do carry a level of cash that others here might think to be very over-cautious

But its not their cash, nor their objective, so the opinion of others is valueless. One might hold a third in hard US dollar bills with a expectation of a 2%/year loss of purchase power as per common 2% inflation rates that central banks might be under remit to target; Another third in gold with a broad expectation of that maintaining purchase power; The last third in stocks with the expectation of a share price that increases broadly by inflation and pays a 2% dividend yield - a 2% real outcome that counterbalances the expected loss of the third in US$. Which might match their objectives of drawdown at 3.3%/year SWR (inflation adjusted) for 30 years to see them through age 65 into their mid 90's beyond which they expect to be in a all-inclusive care home funded by the sale of their home/house. Historically such a choice on average still saw a large proportion of the inflation adjusted start date capital value still available at the end of 30 years if they lived that long. It was the more extreme/exceptional case where if they lived to their mid 90's they'd spent all their investments and were down to living in a care home being funded by the sale of their home, and even then it was more the exception that they were still alive 4+ years into that, by which time most of those won't even know who/where/what they are (someone else's problem).

Another might opt for all stock with similar or even worse worst case outcome. Maybe dying earlier than might have been the case without the stress of periodic high negative side volatility; Considerably better average/best case outcomes - leaving more for heirs/state/charities, but of no benefit to them other than perhaps a comfort of knowing they might have the most grandest tombstone in the graveyard.

[1nvest]

a single inflationary figure will never 100% align with any one particular persons spending habits, but I don't think anyone's really claiming that to be the case

It's a guide. One commonly used as a relative comparison when seeking wage increases during working life, a broad measure of how well or poorly your investments might be performing compared to a basket of others during retirement.

Far from a perfect measure, for instance a MP being awarded a 2% inflation rise on a £80K/wage, £1600/year more, compared to a £20K/year minimum wage workers 2% £400/year more, isn't equally reflective of both perhaps paying £10/week extra to fill up their cars 50 litre petrol tank.

I believe some Court fines have transitioned over to using number of weeks wage as penalty levels, but outside of that its not as though shops will charge you a proportion of your weekly income for a loaf of bread/whatever. Inflation tends to hurt the relatively less well off more disproportionately than the relatively comfortable/wealthy. Countering that and taxation/wealth redistribution should be levelled as a adjustment factor to reduce/counter that. Imperfect measures/actions in a imperfect world.

[GrahamPlatt]

I suppose it's semantics but I wouldn't call cash a "hedge" at the moment. I'd call it a way of losing around 8% purchasing power pa. But each to their own.

But that’s just not true. Why do people not understand inflation? All that matters to me with regard to my cash holdings is my own personal inflation rate, which is governed by which products I decide to buy and which services I choose to use. A lot of that expenditure is discretionary. I’m sorry, but the idea that anyone’s expenditure exactly matches a random basket of 700 items selected by the ONS is a nonsense.

I’m going to have to disagree with you there simoan. Your “personal” inflation argument cuts no ice when the arbiter of your wealth is the wider world. To be clear, say someone’s total wealth is £1m and RPI is 10%. They trim their spending to keep their personal inflation to 5%. This means reducing the quality or quantity of things they buy. And it’s damned near impossible to counter the increase in price of services (e.g. the cost of repairs etc). So they’ve “personally” just had shrinkflation. But by the end of the year, that £1m is viewed by “the market” as now being worth £900k. This is why CPI such a pernicious measure. Substituting margarine for butter and telling people they’re less worse off than they thought is just wrong. “Fuel price rises don’t affect me… I only ever put £20 in”.