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Q: I am a beginning investor and I understand the concept of having a diversified portfolio. But I don’t understand what is considered “cash” in one’s portfolio. Can you help?
–J.R. Johnson, Via the Internet
A: The “cash” portion of a portfolio, which is sometimes called the “cash position” or “liquid position,” refers to the percentage of an investment portfolio that is made up of cash (or other highly liquid securities) that can be used to purchase investments at a later date or saved for retirement. The cash position of a portfolio is generally made up of money held in a money market account; or it can be represented by other securities that are readily convertible into cash, such as short-term Treasury bills or short-term certificates of deposit.
The purpose of having a cash position is to make sure that some of the portfolio is easily available for use and relatively safe from stock market volatility. Many financial advisors advocate that some portion of your portfolio should be held in cash or highly liquid securities at all times. Typically, investors who are closer to retirement age carry a higher-cash position in their portfolio because they have less time to recover from a major loss of assets due to market fluctuations. Investors of any age who cannot stomach market volatility also tend to have a higher-cash portion of their portfolios. Younger investors may choose to convert a higher portion of their portfolio to cash or highly liquid, low risk securities if they are saving a substantial down payment for a home (up to $10,000 of a Roth or traditional IRA can be used for the purchase of your first home). Consult with a financial advisor to determine the best mix of investment choices to best suit your needs.