How Much Cash?

A physician-reader asked me this question at the end of 2007. The answer is still as relevant today as it was then.

Reader: I have all my investable money in cash right now because I don’t know which way the market is headed. What do you think about this strategy?

Dr Mueller’s Answer: First of all, I don’t know which way the market is going either—nor does anyone else. It’s excellent that you recognize this inability to predict the future and accept it. Many people adhere to “optimism over realism” and believe that some or all investment gurus have a crystal ball, which is impossible.

Secondly, you’re not alone in being concerned about losing money in an uncertain market. Harry Markowitz, PhD, the father of Modern Portfolio Theory, felt this type of pain too. When asked about the allotment of his retirement plan he said:

“I visualized my grief if the stock market went way up and I wasn't in it — or if it went way down and I was completely in it. So I split my contributions 50-50 between bonds and equities.”

Professor Markowitz recognized his own fear and vulnerability. He did what felt best to him during market ambiguity.

You are like Dr. Markowitz in that you are worried too. Like him, you recognize that you would be in pain if you lost money. Unlike Dr. Markowitz, however, you are in a riskier position. You may not recognize that by keeping all your savings in cash, you are taking on risk. Why? If the market goes up, you lose money by not participating. If inflation rears its ugly head again, you lose money because the buying power of cash is diminished.

A better approach is to hold a mix of stocks, both US and international, plus bonds and cash in your portfolio. The allocation that you hold of each has to feel comfortable for you. In this uncertain market, you may want to have more cash or short term bonds than usual, but you should still have stocks for the reasons I mentioned.

For more information about this subject, please see: Should You Invest like Suze Orman?