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The Role of Cash in a Portfolio: Searching for Alpha for March 2015

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Cash has become another four-letter word for some investors. Sure, it doesn’t earn anything – which is only slightly less than the yield on high quality, short-term debt – but keeping some immediate liquidity has some real-world advantages. (See monthly index returns table below.)

Probably the most pragmatic reason one might need cash is in case of an unexpected expense. If something suddenly comes up, having some money available (perhaps by not reinvesting dividends or interest automatically) is far better than having to raise the money by selling an investment and incurring potential tax consequences. 

There are also some strategic reasons to keep cash on the sidelines. Many investors, shaken to the core after the Global Financial Crisis, are still hesitant to invest in stocks. I have found that keeping some of the portfolio liquid psychologically enables them to have some equity exposure.

Cash also offers flexibility for opportunistic investors. With U.S. markets boasting valuations far higher than the rest of the world, the performance banner will eventually be passed.  Having some cash ready to deploy not only reduces domestic exposure, it also allows for a quick reallocation when the tide turns.

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