Between civil unrest, a newer, more infectious strain of COVID-19, the unemployment rate remaining stubbornly high, and a market bubble in money losing stocks, investors have good reason to worry. Add to that rising energy prices and other signs that inflation may be on its way back, and today's low interest rates may not be long lived. That could also add pressure to stocks, as many investors had shifted from bonds to stocks in an attempt to get income from their portfolios.
All that worry raises a key question: should investors be stashing cash right now? While that's an easy question to ask, it's not quite as easy one to answer. It really depends on the rest of your financial situation and your time horizon until you need the money. Those factors make a huge difference when it comes to determining whether you should be focusing on stashing cash at the moment.
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When you should be stashing cash
All investors should have a cash buffer of three-to-six months' worth of expenses available to them in case of emergency. If you don't have that buffer saved up for yourself, then you should absolutely be stashing away cash.
The reason is simple: the stock market is a volatile place, and money you thought you had one minute can very easily be gone the next. If you find yourself needing quick cash at a time the market is down, you could be forced to sell more shares than you really want to in order to pay a bill that's coming due. You don't get to choose when you're laid off or your roof leaks or your furnace breaks or you get sick. If it happens at a bad time for you in the market, the related bills will still come due.
On a related note beyond the need for emergency cash, if you know you'll need money within the next five or so years, you should also be stashing away your money in something less risky than stocks. In normal times, you might want to consider duration-matched bonds for that near term money, but with interest rates so low, cash may very well be a good enough substitute. So if you're close to retirement, have kids about to head to college, or have another major expense coming up in the next five years, cash is not a bad idea.
Beyond those spending needs, it's also not a bad idea to let cash pile up in your investing account when things like dividends, corporate buyouts, or other company actions leave you with cash. You might want to get that particular cash invested in an investment with a higher potential return at some point in the near future, but you don't have to make that move immediately. Instead, first find an available investment you're willing to own at a price you're willing to buy it at, and then use that cash to buy it.
In addition, if you find yourself holding onto an investment that you're no longer comfortable owning, it may very well make sense to convert that investment into cash. Reasons to sell include: If your investment thesis is broken; if you can't justify the company's market price based on its prospects; if it has become too large an individual holding; or if you just can't sleep at night because of what you own. Once you sell, it's OK to hold onto that cash until you find a better fitting investment for yourself.
When it's a bad idea to stash cash
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Although the reasons discussed above are great reasons to increase your cash position, there are also very good reasons not to stash away more cash now. For instance, if you're afraid of a frothy market, consider buying in thirds instead of all at once. That way, you have some money invested in case the market continues to rise, but you also have cash already available to invest if prices happen to drop. If you only get one of your thirds invested, take the other two thirds and look at other places to invest.
Similarly, fear of inflation can be a bad reason to shift from stocks to cash. While rising inflation may raise interest rates and thus cause investors to shift to bonds from stocks, remember that inflation generally means the cost of goods and services are increasing. Companies with pricing power are generally worth owning in inflationary times, as they can raise their prices so their revenues can keep up. Many of their costs are likely fixed, so their pricing power also increases their operating margins.
In addition, a rough economic outlook might seem on the surface like a good reason to lighten up on equities, but often time it isn't. Remember that the market attempts to value companies based on their future projections, not what has happened in the past. By the time you as a mere mortal recognize that the near term economy doesn't look all that strong, the market may very well have already priced that bad news in.
As a result, times when the economic outlook appears rough just might actually wind up being the very best times to invest more in companies that look like they will be survivors. If the market has already priced in the bad news, but not the subsequent good news that may appear, then the next surprise move might be to the upside.
To be sure, buying when the outlook appears bleak can be a very scary and challenging task for an investor to actually accomplish. That's a key reason why it's so important to have the three-to-six month emergency fund and to not rely on your stocks to cover any expenses you have over the next five years. That way, you're only dealing with money that you have a chance of keeping invested for the long haul. It makes it much more palatable to take the risk of investing your money when the future looks scary.
So should you stash cash or not?
As the old saying goes, "cash is King." You certainly need enough of it to have a decent emergency buffer. In addition, if you'll need your invested money to cover some of your costs within the next few years, it can be a decent alternative to duration-matched bonds in today's low interest rate environment. If you know that your current cash position isn't sufficient to meet those needs, then stashing away cash right now is an excellent idea.
Similarly if you're considering stashing cash because one or more of your investments no longer fits your portfolio the way it once did, it probably makes sense to address that particular investment. Moving some or all of that capital to cash while you figure out a better home for it is also not a bad idea.
Otherwise, without a compelling reason to stash more cash, you'll probably be better off in the long run by looking for opportunities to invest the money that comes your way. The market has always been frothy, but only those that managed to invest through the short term pain have been able to reliably partake in the subsequent long term gain.
