How much cash should you hold?

State Street Corp. provides big institutional investors with investment research, investment management, investment servicing and trading services. It recently reported on the cash holdings of individual investors. In Canada, individual investors are holding an average 34 per cent of their assets in cash. We think that this is too high for most investors.

We think that some of this cash was raised by investors who bailed out of stocks during the market meltdown of mid-2008 through the first quarter of 2009. If they ignored our advice to buy and sat in cash, they’ll have missed a huge rally. It’s likely they’re waiting for the next crash before reinvesting.

Other investors profited as stocks recouped their losses and went on to set a string of record highs. When things go too well, however, many investors get nervous. For instance, so far we’ve avoided a ‘correction’ (a stock market setback of 10 to 20 per cent). But at some point a correction will strike. It’s likely that many investors are holding cash – to pounce and buy stocks on the cheap at that time.

Cash could send stocks up higher

The trouble is that it’s very difficult to consistently and accurately predict where stock prices are going in the short run. As successful investor Bernard Baruch quipped: “Buying at the bottom and selling at the top can’t be done – except by liars.” But with so much cash sitting on the sidelines, stocks could rise further. State Street found that individual investors worldwide are keeping 40 per cent of their assets in cash. That’s a lot of money ready for deployment.

So just how much cash should you hold? As usual, the answer depends upon your circumstances and your investment objectives.

If you have a safe, high-paying job and you regularly invest, then you need not hold much cash – no more than, say, 10 per cent. After all, if stocks fall, you can use part of your high income to buy stocks.

The chances are that you can invest up to 18 per cent of your income in stocks within a self-directed RRSP – though that percentage would drop if you’re part of the shrinking minority who belong to a pension plan. You can also invest in stocks within a Tax Free Savings Account. The contribution room within these TFSAs is currently growing by $5,500 a year.

If you have a precarious job and earn modest pay, then you’ll want to hold more cash. Otherwise you may lack the resources to buy when stocks fall.

Another consideration is your investment objectives. Let’s say that you invest primarily to generate a stream of growing dividends. In this case, you can hold little cash. Otherwise, you’ll miss out on dividends and their growth. Also, if stocks do fall, you can use your dividends to buy them cheaply.

 

 

The MoneyLetter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846