Chapter 9 - “How Much Cash Should I Hold? - Let's Take a Closer Look" - The Incompetent Investor

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Saturday, February 2, 2019

Chapter 9 - “How Much Cash Should I Hold? - Let's Take a Closer Look"

How Much Cash Should I Hold? - Let's Take a Closer Look

G'day All! I apologise I have not been able to post for a while. I've been really busy organising a new home up in Darwin in preparation for my wife and son to join me from Melbourne. 

They are pretty reluctant to leave their world behind in Melbourne, but I am sure once they arrive they will love it up here! 

They will be joining me in March for a brief period, and then they jet off to India for 4 weeks to visit the extended family! 

Consequently, the next month or two isn't going to be too good for the Family Portfolio. Nevertheless, I will share the dents on the portfolio in the coming months! 

Right, How Much Cash Do I Hold? 

At the moment, we have approximately 13% allocated towards cash. According to Morgan Stanley, published by the ABC in 2018, Australians Debt Levels are 189% relative to their income as a national average. To put this into context, USA, Japan and the UK are lower than Australia. 

It is a bit worrying isn't it? To me, as a simpleton, this means many persons throughout Australia do not have hard cold cash on hand to take advantage of market corrections. Even worse, the capacity to deal with interest rate hikes and other emergencies may be lacklustre. 

Personally for me, if there was a significant correction in the stock market, I would have approximately $10,000 to play with. Not a life changing amount. Although, to me, it is not a small amount either. 

I should note that this $10,000 is technically a buffer for emergencies anyhow. Therefore, moving forward, I intend to get the Equity allocation up to 80% and have 20% in Cash. I hope this translates to $80,000 in Equities, and $20,000 in Cash in the not too distant future (by the end of 2019). 

What Sort of Allocation Do Other Notable People Suggest? 

Benjamin Graham is known to advocate for having 25% in Bonds (or other similar safer instruments). Why? He argues that for most people it will give them the confidence and resilience to get through market corrections when stocks are sinking. 

I know what you are thinking, you have balls of steel and you will never sell your stocks! Try loving your shares when they are down 30-40%. 

It is well known within the Financial Independence community that you are generally better off investing a lump sum as opposed to averaging in over time (also referred to as DCA - Dollar Cost Averaging). 

However, I am quite comfortable with a 80/20 allocation split between Equities & Cash. You can do some further reading on DCA vs Lump Sum investing which was conducted by Vanguard here

What Are the Benefits of Having Cash on Hand?

Peter Thornhill whom I am quite fond of thanks to Strong Money Australia has been well known to welcome black swan events. Let's have a look at some of the black swan events and other historical moments prior to the GFC

  • NASDAQ Index fell 78% by October 2002
  • The Fed cut interest rates to 1% to stimulate the economy
  • 1987 Crash - single day fall of 22% 
  • Asian Financial Crisis 
  • European Debt Crisis 
Above are certainly not an exhaustive list of opportunities for investors, although, it resonates with what Peter Thornhill has been known to preach - which is being prepared for these events and cleaning up! 

Peter Thornhill has also explained that humans frequently fail to absorb and apply previous lessons of history, instead as technology advances, there just seems to be an added twist on how disasters occur (Cufflinks, 2019).

In other words, while technology rapidly advances, it creates new problems which can create opportunities. As it is well known,  technology enabled the USA to sell fraudulent mortgages around the world which sparked the GFC - Absolute disaster!

Point is, we all acknowledge that we cannot time the market. However, in my simplistic view, given where we are up to in the economic cycle, I personally am quite comfortable with having a 20% allocation towards cash in preparation for future unforeseen economic opportunities. 

Final Thoughts 

I shit you not, as I was writing this blog entry, my wife called me and asked me, "Danny, do we have RACV insurance for the car in Melbourne?". I responded frustratingly, "no we do not". 

The cover recently lapsed, and unfortunately, right at this moment we do not have cover! I know rookie mistake, but it is what it is. Thankfully it is just around the corner from home. 

Edit: Small victory, turns out it is all okay now, but my underlying point still remains that unforeseen events do happen hence the importance of having cash on hand!  

In summary, I will need to start building up my cash reserves to deal with life events as noted above and general economic opportunities. I would like to hit $80,000 in equities initially and then I will start building up the cash reserves to 20%.  

What are your thoughts on Asset Allocation in respect to Cash? I am interested to learn from others! 

I should point out that asset allocation is very relative to where you are up to in the process of reaching Financial Independence. For example, somebody with a 1 million dollar net worth may have $100,000 in Cash whereas somebody just starting out may only have $10,000 which is why I think discussion around asset allocation is an important one, particularly for those just starting out! 

Disclaimer: The information on this website is general information and should not be taken as financial advise. I am simply documenting my journey and experience. I am also not a licensed Financial Adviser. You should always seek independent legal, financial, taxation and other advise that relates to your unique circumstances. The Incompetent Investor is not liable for any loss caused, whether due to negligence or otherwise arising from the use of, or reliance on, the information provided directly or indirectly, by use of this website. 

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