Here’s a bit of what I am reading and studying today (via PIMCO):
“What should be my portfolio’s allocation to cash?” Investors wrestle with this question, and of course, there is no clear-cut answer. Determining optimal portfolio allocations to cash requires a holistic analysis of liquidity needs and risk tolerance, as well as prevailing and future investment opportunities. Given that today’s markets remain unusually uncertain and are increasingly driven by policymakers’ decisions, finding an answer to this question is as challenging as ever. We believe understanding the multiple roles cash can play in investment portfolios and having a general framework can help investors make this important allocation decision.
Defining cash allocations and liquidity
Cash can be thought of as a store of value, a medium of exchange and a unit of account. Often, “cash equivalents” are considered current fixed income assets with maturities or durations of about one year or less that can help investors meet their needs for liquidity. However, during the financial crisis several instruments deemed by some as “cash equivalents,” such as municipal variable-rate demand notes, became highly illiquid and suffered large losses. Therefore, we believe investors should consider and differentiate the concepts of cash equivalents and liquidity.
Liquidity is a multi-dimensional concept, largely captured by four parameters:
- Immediacy: How quickly can a position be established or exited?
- Width: How wide is the bid/ask spread?
- Depth: What volume can be transacted at prevailing prices?
- Price impact: Does the market move, and for how long is the
price reset, as a result of your transaction?
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.