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Introduction

In various places on this web site, I suggest that holding cash as an integral component of your portfolio mix is a way of diversifying risk.  In the briefest terms possible, keeping cash on hand lowers volatility, saves you selling at the wrong time and gives you the opportunity to buy cheap assets without notice.  In essence I prefer what is called the ‘cash plus risk’ investment approach to the traditional portfolio construction based on the assumed non-correlation between equity shares and fixed income or loan stocks.

Where to keep it?

In practice there are 3 main ways you can hold cash as part of your investing strategy:  in your bank, building society or other deposit taking institution (or in your sock, if you really must!), as part of your platform or wrap assets, or in the control of the fund managers you select.

It is worth mentioning that the managers of funds that list as a primary objective investing in stock markets assets have inconsistent views on holding cash within their funds:  some say it is not their job to hold cash and they will always be fully invested, others say they must hold cash to manage liquidity (common for property funds) and a third group hold cash as a tactical asset (especially in absolute return funds).  If you get a ‘drill down’ analysis of your funds portfolio from your adviser or platform supplier, you may well find you are more into cash than you thought!

Holding cash in money market unitised funds that invest in deposit like instruments like floating rate notes or synthetic zero dividend preference shares (that can still fall in value but are low volatility) only works if the long term returns are better than bank interest rates after tax plus the fund fees.  That is sometimes the case, but the best funds will show losses for periods, albeit they recover over time.

Holding cash in private accounts is the favoured approach of most investors because they are in control, can keep an eye out for the best products from banks and building societies and have instant access.  Tax favoured offerings from National Savings are a good bet at times depending on Government policy to borrowing direct from the public which varies a fair bit.

Keeping cash in your platform or wrap account is ideal if you are going to use the money for dealing quite soon, but interest rates on such money may currently be negative after fees are taken into account, so I would suggest such holdings would usually be short term.  The better platforms do offer access to fixed term deposit accounts to squeeze a bit more interest out of the system, but of course that may constrain an opportunistic quick buy of an asset you just decided was priced where you liked it!

My view

I think only modest amounts, intended for dealing (possibly raised from recent asset sales) should be kept on platforms.  I think your cash ought to be in your control, but that you ought to know that “investment cash” is separate from your day to day funds and any emergency reserve for unexpected capital items that you like to keep.

It helps if you keep that portfolio strategy cash noted in your records with your other portfolio asset data if you want to measure your returns accurately.  In good times, the cash holding will be a brake on performance and there will be a psychological ‘itch’ to invest it but when markets fall, it will be something you can access while you wait for things to get better and the psychology will all be positive!

Actually, in my opinion, holding a good cash reserve is not really a brake on good performance long term, because you can make the assets you do invest in that bit more adventurous and over time that will generally pay you back with better returns.  Recent research supports this supposition over more time periods than not.