This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on Dec 7 - 13, 2015.

Ong Shi Jie (CJ) is head of integrated marketing and analytics at OCBC Bank (M) Bhd.

GIVEN the performance of equity markets this year, anyone who has held on to cash would be counting his lucky stars for not being exposed to the whimsical movements of the markets. But then again, someone who loves sitting on cash would be counting his lucky stars anyway — regardless of how the markets perform. Cash lovers are always stuck in a wait-and-watch mode, waiting for the right time to deploy their money. But is there ever a right time to enter the markets? And so, many of us remain stuck in love with our cash and the perceived safety it offers. 

I say “perceived safety” because, really, is holding cash all that safe? I would argue no. When we sit on cash, our money becomes a sitting duck for inflation to sink its teeth into and rob us of our purchasing power. It may sound a bit melodramatic, but there’s no denying that when we do nothing, our cash is almost guaranteed to decrease the following year due to the somewhat inevitable rise in inflation. That’s a fact. 

So, can too much cash be a bad thing? The answer lies in how much you are sitting on and why you are holding it. Don’t get me wrong; everybody needs to keep some cash. Besides paying for our daily needs, we may need it for emergencies. While having a cash buffer is almost a matter of financial discipline, the problem arises when we hold on to more than we need in the short term. 

From market research that OCBC Bank conducted among the middle income group, we found that 75% of the respondents’ liquid assets were held in cash. This worked out to almost 11 times their monthly salary. What is more interesting is that fewer than two out of 10 individuals had thought about asset allocation. On top of that, of those who had investments, two out of three held only one investment product, indicating clearly that their portfolios lacked diversification. This also seems to indicate a lack of understanding of portfolio investing, which could significantly mitigate investment risks. 

So, back to that question of how much cash is enough. For a start, my first piece of advice to everyone out there is to distinguish between household cash and portfolio cash. Household cash is the cash you hold in bank accounts as emergency funds. A rule of thumb is to stash away six months’ salary for this purpose. But those whose lifestyle needs are fairly routine can even go as low as two months’ worth of expenses. Once you have determined the amount needed for your cash cushion, you can look at your portfolio cash.

Portfolio cash is the proportion of your investable assets held in cash. Let’s say your monthly salary is RM8,000, and you have RM100,000 in cash and RM30,000 in investments. The amount you should hold as emergency funds or household cash is six months’ salary, or RM48,000. The remaining cash, RM52,000, is your portfolio cash. So, your total investment portfolio is RM82,000 —  RM52,000 (64%) in cash and RM30,000 (36%) in investments. 

From the example above, is holding 64% of your investment portfolio in cash too much? (Notably, these numbers are very close to the averages we found in our market research.)

In the investing world, having “too much” cash can be a risk and determining how much is “too much” can be a controversial subject. Charles Schwab discovered this in March when the firm launched Intelligent Portfolios, an algorithm-based platform that builds and rebalances portfolios automatically, similar to the asset management services of robo-advisers. Charles Schwab’s methodology, which allows allocation to cash from as low as 6% to as high as 30%, received scathing remarks for allowing such high cash allocations. It received remarks such as “Why would an investment service purposely not invest almost a third of your account?”, “a client unfriendly product”, “at 30%, it’s almost criminal” and a lot worse! Charles Schwab responded by saying there is no right or wrong answer to how much cash an investor should hold as an investment — it is a strategic decision.

So, the million dollar question isn’t “How much is too much?”, but rather “Why are you holding that much money in cash?” What is your strategy? Did you panic because of a sharp market decline and sold out, leaving that money sitting on the sidelines? Are you afraid the markets have peaked and are taking profit and positions off the table to avoid losses? Are you keeping a portion in cash waiting to jump into the next investment opportunity? Don’t have an answer?

Let’s put it this way. If you are keeping cash because you are afraid of the future or are trying to time the market, chances are holding cash isn’t a very good strategy. It is probably a result of having no strategy. Markets are cyclical and the average investor is bad at timing the market. Having too much cash in your investment portfolio is called “cash drag”, simply because that cash doesn’t produce any yield. That means you have assets that are idle that could be put to work to yield a return. That also means having too much cash is a risk. So, in my example where 64% of the portfolio is idling in cash, it means almost two-thirds of the portfolio is not yielding an active return. Think about how hard the remaining one-third of the portfolio would have work to produce a meaningful total portfolio return of 6% to 8%. 

As Charles Schwab put it so eloquently: holding cash is a strategic decision. It shouldn’t be a reflection of your emotional levels. If you are worried about choosing the wrong time to enter the market, consider a dollar cost averaging strategy. If you are worried about peaking markets, you must have clear indicators on when to re-enter the market to avoid any extension of a bull run. If you are waiting for investment opportunities, be clear on what type of investment opportunities you are looking for.

Cash is king only if you find opportunities to deploy it. Otherwise, too much of it may not be a good thing. 

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