The question of how much cash to hold during a market downturn is one that many investors grapple with.
While some may feel compelled to sell off their shares in response to turbulent markets, others may be more comfortable staying the course, trusting in the long-term potential of their investments.
Indeed, Warren Buffett's Berkshire Hathaway reported a US$330 billion ($525 billion) cash pile on its books at the end of 2024, it's highest on record.
But how can we determine the right balance? Let's dive into the expert insights to guide your decisions.
Cash in the current market
With the S&P/ASX 200 Index (ASX: XJO) and global markets facing uncertainty right now, it is no surprise that investors are asking whether they should hold more cash.
Goldman Sachs revised its market outlook for the US S&P 500 index this week, predicting short-term declines of 5%, and longer-term gains of just 6%.
The downward revision was underlined by concerns over rising tariffs and recession concerns, and is the 2nd this month.
But what does this mean for your portfolio? Does this mean to run for cash hills?
During market downturns, cash can feel like a safe haven. It offers liquidity, reduces exposure to market volatility, and allows for flexibility if opportunities arise.
But the challenge lies in balancing that safety with the potential for growth. As The Australian Financial Review reports, anyone who sold "at the bottom" of the market in various market crashes fared worse than someone who simply stayed in shares.
Part of the reason is missing out on any market recovery. And, locking in potential losses. If you had sold during the 2008 downturn, or the Covid-19 selloff, you would have missed the substantial gains and investment returns that followed.
A hypothetical investor who sold at the bottom of the GFC in 2008, then bought back twelve months later, has $1.15 million in value today, versus $1.75 million for one who just stayed put, The AFR notes.
Meanwhile, Morgan Stanley offers sage advice on what common pitfalls to avoid when thinking about one's portfolio cash balance. It too notes that, missing out on the recoveries, is a cardinal investment sin.
Going to cash and 'staying there', the broker says, "compounds the damage from panic selling".
The strong rebound in stock prices that often follows a market downturn should underscore how bailing out can cost you when the market reverses direction…an investor who sold after a 30% market drop and stayed in cash would have just $524,000 after more than 45 years, even after investing $5,000 a year.
What to do instead?
In times of market uncertainty, it's crucial to stay disciplined and stick to a long-term strategy. That means avoiding too much in cash versus direct investments.
In fact Goldman Sachs says investors should "be wary" on holding "hefty" amounts of unallocated funds in portfolios.
One approach to help navigate this volatility is dollar-cost averaging (DCA). This strategy involves regularly investing a fixed amount into your portfolio at set intervals, regardless of market conditions.
Over time, the data shows this could smooth out the impact of fluctuations and help avoid the pitfalls of trying to time the market.
As per The AFR, a hypothetical investor that followed a DCA strategy has seen an average 8% return per year since 2008, and sat through the GFC, the Covid-19 crash, and the 2022 market selloff.
Morgan Stanley agrees in principle, noting that, if you do hold funds ready to invest, DCA "can be a good way to get there".
Dollar-cost averaging reduces the sensitivity of your portfolio to the luck of timing, which can make it easier for fearful investors to move out of cash, since they can avoid the worry of putting a big chunk of money into the market, only to have the sell-off resume. And if the market rebounds, they will be glad that they already put some of their money back to work, rather than having all of it on the sidelines.
Meanwhile, Goldman Sachs agrees, noting that DCA is a good strategy to roll funds into the market "bit by bit".
We always advise to build positions gradually, especially for clients who are investing big sums of money for the first time. And when we get inevitable pullbacks of 5% to 10% or more, accelerate the process to enter the market at more favorable prices.
Foolish takeaway
So, how much cash should you hold during a market downturn? The answer depends on your personal financial situation, goals, and risk tolerance.
While it can provide short-term safety and flexibility, long-term investors should focus on sticking to their strategy and avoiding knee-jerk reactions.
By maintaining a well-diversified portfolio, rebalancing when necessary, and employing strategies like dollar-cost averaging, research shows you can navigate the ups and downs of the market without sacrificing long-term growth potential.
