Why cash could be a killer for your portfolio

Holding too much cash in your portfolio could be a major mistake.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Deciding how much cash to hold in a portfolio is a tough choice for any investor to make. On the one hand, some cash is a necessity. It is required to take advantage of inefficient short-term pricing of assets which could lead to profitable investment opportunities for the long run. However, cash also reduces the overall returns of a portfolio, since it offers a modest return in comparison to shares.

Looking ahead, cash may become an even less efficient asset. Global inflation is expected to rise, and with world stock markets making gains there could be a valid argument to reduce cash levels to extremely low levels over the medium term.

Inflationary outlook

While the world has experienced a decade of deflationary forces, higher inflation looks set to take hold in future. Deflation has generally been avoided since the financial crisis because of the ultra-loose monetary policies pursued across the developed world. They have helped to keep the price level rising, albeit at a relatively slow pace. As such, the real return on cash has generally been negative, but has not been poor enough to discourage investors from holding sizeable chunks of their portfolios in the asset.

Now though, the prospect of higher spending and lower taxes in the US may create higher inflation. This could be exported across the globe and lead to an even worse real return on cash over the medium term.

Rising share prices

While global stock markets have enjoyed a major Bull Run in recent years which has increased the opportunity cost of holding cash, further share price gains could be ahead. There seems to be a cautious standpoint from Central Banks across the developed world regarding the pace of monetary policy tightening. This may lead to low interest rates and stimulus packages being left in place for longer than they perhaps should be. The result of this could be rising share prices.

Certainly, some stocks appear to be overpriced after their gains in recent years. However, a number of industries such as oil and gas, mining and the banking sector may still offer high levels of upside potential. They could prove to be the catalysts for further stock market gains. Holding too much cash within a portfolio may therefore have an increasingly negative effect on overall returns versus a more efficient portfolio.

Takeaway

Holding some cash within a portfolio is prudent. Share prices are usually volatile, and having cash on hand can create the opportunity to take advantage when high quality companies are trading at relatively low prices. However, holding too much cash reduces overall returns. With inflation forecast to move higher and stock markets still on a major Bull Run, the opportunity cost of cash as an investment may increase over the coming years.

Therefore, focusing on shares through a buy-and-hold strategy could be a sound move for Foolish investors to make at the present time.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

More on Investing Articles

Person holding magnifying glass over important document, reading the small print
Investing Articles

2 top FTSE 250 investment trusts trading at attractive discounts!

This pair of discounted FTSE 250 trusts appear to be on sale right now. Here's why I'd scoop up their…

Read more »

Smiling young man sitting in cafe and checking messages, with his laptop in front of him.
Investing Articles

3 things that could push the Lloyds share price to 60p and beyond

The Lloyds share price has broken through 50p. Next step 60p? And then what? Here are some thoughts on what…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

£1,000 in Rolls-Royce shares a year ago would be worth this much now

Rolls-Royce shares have posted one of the best stock market gains of the past 12 months. But what might the…

Read more »

Investing Articles

Are HSBC shares a FTSE bargain? Here’s what the charts say!

There are plenty of dirt-cheap FTSE 100 banking stocks for investors to choose from today. Our writer Royston Wild believes…

Read more »

Three signposts pointing in different directions, with 'Buy' 'Sell' and 'Hold' on
Investing Articles

Just released: Share Advisor’s latest ‘Hold’ recommendation [PREMIUM PICKS]

In our Share Advisor newsletter service, we provide buy, sell, and hold guidance for our universe of recommendations.

Read more »

Investing Articles

Investing £5 a day could help me build a second income of £329 a month!

This Fool explains how £5 a day, or one less takeaway coffee, could help her build a monthly second income…

Read more »

Smart young brown businesswoman working from home on a laptop
Investing Articles

2 FTSE income stocks investors should consider buying in April

Income stocks are a great way to build wealth. Our writer details two picks she believes investors should consider snapping…

Read more »

Investing Articles

What might the 5-year price chart tell us about BT shares?

Christopher Ruane considers what clues the long-term performance of BT shares might offer him about business performance and whether to…

Read more »