Mohammed El-Erian, formerly of PIMCO, stunned a few people when he announced recently that his portfolio primarily was in cash. I know a lot of small investors also are heavily weighted in cash, because they’re afraid of all the other investments. Here’s an analysis of why you don’t want to be 100% in cash in any market environment.
The simple reality of the financial markets is that someone somewhere always ends up holding cash. Someone always feels like they’re falling behind. So don’t feel so bad about that part. But a 100% cash position is entirely irrational most of the time because it leaves you totally unprotected against inflation. For most investors, even the most conservative, we should be protecting against two risks:
- The risk of purchasing power loss.
- The risk of permanent loss.
Let’s make an extreme point here for emphasis. Stocks might be risky, but that risk can be largely offset inside of a diversified portfolio. We all want the high return of stocks, but we don’t want the rollercoaster ride that comes with it. The reason we try to own uncorrelated asset classes is specifically so we can hedge the risk of high volatility assets like stocks. And if we look at the performance of an extremely bond heavy portfolio we can see just how much stocks help boost a portfolio.