Q&A: How much cash should you keep in your portfolio?

How much % cash (dry powder) do you leave in your portfolio? As a general rule, one should always save some dry powder for good buying opportunities. How much reserve do you usually keep in your portfolio?

I think there are two reasons to hold cash in an investment account:

1. To fund regular monthly/quarterly withdrawals (source of income).
2. If the alternative to cash is a bad bet.

For this discussion, let’s just focus on the second reason. I disagree with the idea that you should always save some dry powder. When good opportunities present themselves, there is no reason to pass them up in favor of some vaguely defined better opportunity that might come along someday.

It’s important to acknowledge that the best opportunities are almost never obvious in advance. If you lay in wait for an ideal circumstance where everything feels just perfect, you will be waiting for a very long time. Fortunately, we don’t have to find perfect investments – we just have to find investments that are superior to cash.

For example, let’s say that my asset allocation plan dedicates up to 20% of my portfolio to real estate (REITs). I will invest up to the prescribed limits, but only when my rules for entry have been met. I use a set of defined, measurable prerequisites that must be satisfied before any investment can be made. If the investments do not qualify, we hold cash instead. The object is to only invest when the odds of success are favorable. When the odds are against us, we wait. Basically, in this example, we are comparing REITs vs. cash and putting money on the side that offers the highest probability for a positive return.

So, when you ask, “How much reserve do you usually keep in your portfolio?” the answer is, “it depends.” During bad conditions, when the odds of success are low, our cash level is likely to be high, while favorable conditions across all asset classes will allow us to become fully invested. This isn’t an effort to time or predict the market, it’s mainly a process designed to sidestep those periods that contain the greatest risk of substantial loss.

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