Sunday, 15 May 2016

How much cash to hold in our portfolio?

I have discussed the cash component of my portfolio in some detail in my previous posts but I have not dedicated an entire post about cash yet. Given that about one year has passed since we started seriously investing in Singapore in May 2015, it's a good time to discuss in more detail the role of cash and the amount of cash we hold in our portfolio.
Why do we hold cash in our portfolio?

In my asset allocation post, I discussed how we hold cash for the three main purposes of Emergency, Spending and Investment. I will give an overview of how we have been using our cash for these purposes.

Emergency 

We have set aside Emergency cash holdings to be used in the event of financial emergencies. We have yet to experience these unpredictable and life-altering events in the past year but I should mention that the risk of retrenchment has increased. We try to exercise about twice a week to keep ourselves active and healthy in the hope that this reduces the risk of medical emergencies over time. So far, the draw down of our Emergency cash holdings has been minimal.

Spending

This is where we set aside cash for paying our monthly mortgage, credit card and travel expenses. The draw down of our Spending cash holdings has been much more frequent and significant. Our living expenses are higher than average and it's been something we have been working on to reduce.

Investment

We hold quite a bit of cash for investing into ETFs and shares every month.  The draw down of our Investment cash holdings has the widest variations. When the markets are down like in Jan and Feb 2016, we use these cash holdings to make significant investments. When the markets recovered in Mar and Apr 2016, we didn't use much of these cash holdings and allowed them to build up.

How much cash to hold in our portfolio? 

This is one of the most important questions we should ask ourselves when constructing an asset portfolio. It depends on so many factors that there's no one-size-fits-all answer. I'm going to try and apply what I have read to our situation so you can have a real-life illustration of these factors.

Risk of retrenchment

Our salary is the main source of income that allows us to build up these three cash holdings. However, the risk of retrenchment affects the Emergency cash holdings the most. A good way to look at it is how many months can you live on the Emergency cash holdings (ignoring all other cash holdings) when you lose your job.

In our scenario, if we both lose our jobs at the same time (assuming no changes to lifestyle), our Emergency cash holdings can last for 6 months before it runs out. Of course, it's more likely that we will adjust our lifestyle and start paying more of the mortgage from our CPF. This can probably stretch the Emergency cash holdings to 12 months.

Fixed and variable expenses

The amount of monthly fixed and variable expenses affects the Spending cash holdings the most. Due to our higher than average living expenses, we hold about 3 months worth of Spending cash holdings. Since this should continually be replenished by our salary, dividend and interest income, we don't think it's necessary to hold more than that especially if we have a sufficient Emergency Fund.

It's important to assess how difficult it will be to reduce your fixed and variable expenses. The more flexibility you have in adjusting these expenses downwards, the less Spending cash holdings you have to hold. We have identified the areas in our fixed and variable expenses where we are working on reducing the amounts spent. This is a continuous process and a good exercise in budgeting.

How do you plan on investing during bear markets and downturns?

For any investor, it's essential to have a strategy during bear markets and downturns. It's even more important that you execute this strategy effectively when the time comes. Our strategy is to invest into ETFs and shares every month, less in good months and more in bad months. We try not to time the market but we do adjust the amount we invest depending on the market performance in the month.

This requires us to have sufficient Investment cash holdings to buy the ETFs and shares every month. It's probably higher than average to allow us to execute our strategy of increasing these investments during bad months. Depending on the severity of the bear markets, the draw downs can be significant. More importantly, we don't let these Investment cash holdings increase past a certain level to keep ourselves vested in the markets for the long run.

Ultimately, how much cash to hold in your portfolio becomes a question specific to your circumstances. I agree with the argument that for a couple at our age, we should aim to hold less cash and more equities since that should translate to a higher return over a long investment horizon. However, I also think that having a long investment horizon means we can afford to be more patient with our cash. We can take our time to deploy the cash slowly but efficiently. As such, we have a high regard for cash and continue to hold more of it where possible.

5 comments:

  1. I'm trying to correlate to Aus - what would be some examples of ETFs and shares that you did in the past while you were here?

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    1. I used to own ASX shares such as NAB, ANZ, Origin, Fortescue and Woolworths. I didn't invest in ASX ETFs as I was not aware of them at that time. Hope this helps!

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    2. did you gain much profit? since stocks/shares in Australia is not like the US

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