What does it Really Mean to Have Cash? Cash Equivalent Investments that are available By Mo2

“Mo2 You dummy, cash is the paper that you have in the wallet you buy stuff with!”

Ok, you’re right, I lose. I could end the article here, but I’d like to take the time to write about what it means to have cash or cash-equivalent investments in your portfolio.

Liquidity, an important factor of making it cash
The ease of selling a security determines the liquidity of an investment. Which means, if you own a stock that will sell anytime that the market is open, then you are invested in a liquid stock. If you own real estate that might take two months in the current market to sell, it is relatively illiquid. Having cash-equivalent investments means that you can sell them super quick and come up with the real “cash” so that you can use it right away.

“Oh rainy day, when are you going to come?”
In the financial world, you hear a lot about the “rainy day” or the day when you’re going to need a tidy sum of cash and quick. Having a cash-equivalent part of your portfolio will help you take care of rainy days. Some say you can consider credit cards and use your line of credit at the bank for such occasions. True, but both of these options are “borrowing” money which if you haven’t figured out by now, isn’t exactly a good idea for your financial health. Of course, there’s always good debt and bad debt, but that’s just another article.

Savings Account
The most basic form of cash is cash itself. You can keep money at your retail bank in a savings account. If the purpose of this account is to keep money away for a rainy day or for your investment portfolio, look for a bank that actually pays you decent interest relative to the national bank’s interest rate. If you’re getting 0.5% interest for your savings account when the Bank of Canada’s rate is at 5% you’ve got issues (so does your bank).

Government Bonds and Treasury Bills (T-Bills)
Want a risk free investment? You’ve come to the right place. You can invest in your government by lending them money and getting a decent return, relative to th risk, and not have to worry about losing the money. This might depend on where you live, but for the most part if you don’t expect your government to go bankrupt, then you’re pretty darn safe. T-Bill returns are often considered the “risk-free rate”.

These two are great places to keep your cash. Government bonds can start from $100 in Canada for Canadian Savings Bonds and can go up pretty high for some T-bills like $50,000. But there’s sure to be an investment that will suit your portfolio.

The Percentage of Cash You Want
Asset allocation is important within a portfolio. You need to understand your risk tolerance and then decide how you want to allocate your money into the assets you are considering to buy. So if you are risk averse and can’t stand the idea of having your portfolio drop by 10% (or much more in many instances) then you might want to consider putting more weight into cash and fixed-income securities.

The general rule seems to be to have at least 5% cash and up to 15%. Many say 10% but I think it really depends on the size of your portfolio regardless of risk tolerance. If you have a $5,000 portfolio then you might want to make it grow so you should have more weight in equities. But if you have a two million dollar portfolio and had 15% invested in cash. At a 3.5% return on your $300,000 cash (that’s 15% of $2,000,000) then you’re looking at $10,500 annually. Just from investing in risk free investments. So it really depends on what you are trying to get out of your portfolio.

 

Mo2 Thinks
Everyone should have cash. Not just in their wallet but in terms of their investment portfolio. The percentage that you want it to take up is entirely up to you but should never be lower than 5%. The more you have the less risk you may be taking, but that can also depend on your government’s well being. Make your portfolio something that’s comfortable to work with. If you’re biting your nails every time you’re making a move, then you might want to rethink your overall strategy and change your asset allocation percentages.

Cash is great to have because in the case that something happens, you can take money out of your investment portfolio to take care of things. You want to refrain from using too much credit in these cases unless you know you can pay it off right away. Of course, if you’re using your credit card to simply rack up points, that’s ok too (See Becoming a Smarter Credit Card User Article here). But if credit is the only source for your rainy day, then you’ve cornered yourself. As a general rule they (always wondered who “they” are) say you should have at least 3 months of your pay check tucked away under your pillow just in case. Ok, the pillow thing is a joke, but you get the drift of what I’m talking about.

I think it takes discipline to invest in cash-equivalent securities. If I invested $1,000 in cash and got only 3.5% return why not go for a fixed-income security that yields 6%? Well, the reason is again, you need to make sure you have cash just in case something happens and that’s one of the main purposes of this part of your investment portfolio. Hope this gives you guys some ideas! Happy investing~!

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If you would like to comment on this article or anything on this website, please feel free to e-mail Mo2. He can be reached at Mo2@Mo2Thinks.com. Thank you for visiting!