Holding Cash
There were two interesting articles about holding cash yesterday. One was about retirees holding several years worth of cash (click here to read) and the other was about companies holding cash on their balance sheet (click here to read) . What is interesting is that both articles came to the conclusion that holding large amounts of cash is detrimental to overall performance. However, both articles miss the same critical point – individual circumstances and a holistic view need to drive individual decisions.
First, I will address the study from the Journal of Financial Planning and retirees holding several years of cash, aka a Bucket Strategy. The authors of both the study and the commentary I linked to assume that the cash portion is not considered in the overall asset allocation decision and income distribution strategy. Implemented properly, the Bucket Strategy allows the investor to use a more aggressive asset allocation because the large cash bucket provides additional safety. This is where working with a professional who understands your individual circumstances, takes a holistic approach and has the ability to create a truly customized plan come into play. For example, a retiree might initially want to use a 50% cash/bond, 50% equity asset allocation. However, if enough cash is set aside, the same investor may be willing to use an overall asset allocation 40% cash/bonds and 60% equity, which over the long term is expected to return higher total returns. Companies that have its clients complete a risk tolerance questionnaire, send that questionnaire half way around the world then give the answer to the broker/adviser to implement, can’t create the customization of your plan discussed above.
On the company side, the assumption is that all the cash being held on the balance sheet is available to pay down debt or fund a dividend. Again, we need to look at the individual circumstances. What if the cash is located in subsidiaries in China, Germany and Brazil? The company would need to pay US taxes on that money before being able to pay its US shareholders a dividend or pay back its US bond holders. For more details about this, see my comments posted under the name “Jeff94”.