When it comes to investing, we sometimes overlook the importance of holding cash in our portfolio. In fact, it actually plays a pivotal role in your investment strategy, especially when navigating through the unpredictable terrain of bull and bear markets. Hence, understanding what we should do to our cash position during these market cycles can let us better prepare for the opportunities and risks they present.
Before moving forward, let us first define what a bull and bear market are. A bear market is defined by a decline of at least 20% from its previous peak, while a bull market starts at the lowest point following a drop of 20% or more and continues until the next high.
The chart below lists the U.S. bull and bear markets since 1942. It shows that the average bull market lasts longer (4.2 years) than the average bear market (11.1 months).
Source: First Trust The role of cash in your portfolio
Cash is often regarded as the only ‘true’ safe haven asset during market turbulence. Cash offers liquidity in times of economic uncertainty, providing significant benefits. A key advantage is that it allows for opportunistic purchases when company valuations decline to attractive levels. Additionally, cash also acts as a buffer against market downturns and reduces portfolio volatility.
For instance, a 10% market decline for a fully invested portfolio will result in a loss of the full 10%. By reducing the market exposure to 80% with a 20% cash position, the same market loss results in a portfolio loss of only 8%. It gives you peace of mind, which can reduce the chances of panic selling when the market is volatile.
Factors to consider
The appropriate cash level for your portfolio varies depending on your unique circumstances and market conditions. Below are some factors
