Every investor has a different threshold for how much cash to keep on hand in a brokerage or retirement account. Retaining enough of this asset in an investment portfolio is important, since many major brokerages…
Every investor has a different threshold for how much cash to keep on hand in a brokerage or retirement account.
Retaining enough of this asset in an investment portfolio is important, since many major brokerages require up to three days for money to settle into a trading account from a bank.
When you take a profit and sell a stock, the Securities and Exchange Commission dictates that funds take two business days to settle into an account before the proceeds can be used to buy other stocks. Keeping some cash on hand can help an investor buy more shares of a stock or exchange-traded fund, known as an ETF. This is especially true when dollar-cost averaging is part of an investing strategy.
Here are a few considerations that investors should weigh when determining their asset allocations.
While expert recommendations vary on the amount of cash that should be kept in an account, some robo advisors like Charles Schwab’s Intelligent Portfolios may allocate 6 to 10 percent in cash based on an investor’s risk; this is done using an algorithm-based that builds and rebalances portfolios automatically.
Mike Loewengart, chief investment officer at E-Trade Financial, says, “A good benchmark to follow is to hold between 2 and 10 percent in cash in a portfolio, depending on your goal.”
“If you’re a millennial or a Gen Z investor, you have a longer runway, so you may want more of your money to go to work for you over the long term,” he says. “On the other hand, if you’re in or near retirement, you may want a larger cash allocation either as a ballast or for liquidity emergencies.”
Investors should not allocate more than 5 percent of their cash into a brokerage account, says Edison Byzyka, chief investment officer of Credent Wealth Management in Auburn, Indiana.
It’s possible to keep too large of an amount in a portfolio, sitting there in the sidelines.
“You can absolutely have too much cash,” he says. “For investors with at least a 10-year time horizon, maintaining cash levels in excess of 5 percent may produce a notable performance drag.”
C.J. Brott, founder of Capital Ideas, a Dallas-based wealth advisory firm, says holding too much of this liquid asset in your account can drag down overall returns with the currently low interest rates.
“If the average equity market rate of return over the long term is 8 percent and you hold more than about 10 percent in cash, it will probably reduce your overall portfolio return enough to make it no longer worth the risk of being invested in equities,” he says. “The exact percentage amount will always be a function of risk-free rates on cash.”
The danger of leaving assets in cash is missing an opportunity or trying to time the stock market.
“You run the risk of having your purchasing power eroded over time due to the impact of inflation,” Loewengart says. “While market swings can be nauseating, it’s important to remember that unless you’re near retirement, you’re likely investing for the long term.”
Even though savings rates have risen in the past few years due to moves by the Federal Reserve, the returns on cash are still very low and unlikely to generate enough revenue.
“If it’s a loss of principal that’s keeping you from engaging in the market, consider weighting your portfolio heavier toward fixed income, but don’t sit on the sidelines,” he says.
Figure Out Your Asset Allocation Strategy
While some investors believe you should allocate more cash into your account during certain times of the year in anticipation of earnings season, the Santa Claus rally or other potential uptick in the market, avoid trying to time the market, Loewengart adds.
“At the end of the day, the old proverbs about market seasonality are pretty much just noise. Block it out and focus on your goals and personal situation,” he says.
Byzyka says investors should not guide their cash balance based on such subjective adages.
“The statistical significance that selling in May will occur or that the Santa Claus rally will materialize is very weak,” he says. “For those investors with at least a 10-year time horizon, avoiding such mentalities tends to be best.”
Determining a schedule of when cash is deposited into an account ahead of time is a good strategy. Automating deposits with a monthly direct deposit from an investor’s bank to the investment account is even better because it helps avoid emotional decision-making and takes out the guesswork, Loewengart says.
Many raises and promotions occur in the early part of a year, so now is a good time to make a plan, he says.
“For those lucky enough to earn one, kick an automated investing plan into gear, and you’ll never feel the loss of income from your paycheck. Review recurring deposits at least annually to determine if any adjustments need to be made.”
Adding cash to an account monthly tends to produce “relatively positive results over the long term, but investors should strongly consider switching the frequency to weekly when equity markets have experienced downside in excess of 10 percent to 15 percent,” he says. “A shift may allow for a quicker reaction to potential market upside.”
Overall, ensuring there is enough money in a brokerage account allows investors to take advantage of any volatility in the stock market and is always a good strategy.