Cash gets a bad rap.
It doesn't earn much, especially these days because inflation eats away at it. Cash doesn't benefit from the magic of compounding, and it doesn't have the sizzle of stocks.
But cash is great in one's pocket and pure opportunity cost in a portfolio.
When times are tough, there is nothing better than cash. And even when times are good, cash can help a portfolio a lot more than many might think.
Here are three reasons why:
1. Cash Helps Reduce Market Risk
Every day, assets such as stocks, bonds or gold rise or fall in value. Investors can't predict what tomorrow will bring, unless they have cash.
Sure, over time, inflation, if there is any, will eventually destroy the value of cash. But tomorrow, next week, next month or even next year, cash will still be worth roughly what it is worth now.
2. Cash Is the Perfect Hedge
A hedge is something that is used to reduce risk. When it comes to an investor's portfolio, a hedge helps minimize losses when an investment drops in value.
Hedging might involve owning two negatively correlated assets, that is, assets with prices that move in different directions at about the same time.
Think of a hedge as a backstop. It is there to prevent things from getting too bad when investments don't work out as hoped.
For example, say an investors has $50,000 in stocks and $50,000 in cash, and the stocks drop 5%. Now, that investor has lost money on the stocks.
But the value of the cash hasn't changed at all, and let's imagine that it has even earned 1% interest. The investor would be down $2,500 on the shares, but if an investor has gained $500 on the cash from interest, the overall portfolio would only have lost $2,000.
That is just a 2% loss instead of the 5% loss that the investor would have had if he or she were 100% invested in shares.
Cash is the easiest way to hedge. Regardless of what happens in the market, the value of cash won't change. But if the market falls, the cash held suddenly has more buying power, allowing an investor to buy more shares with it than was the case yesterday.
Perhaps best of all, cash is simple to hold, easy to understand and it doesn't cost anything to hold it. Investors don't need to deal with a broker trying to sell them some complicated way to hedge.
3. Cash Is There When Needed
Legendary investor Jim Rogers once explained how he invested this way: "I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up. I do nothing in the meantime."
What Rogers was talking about wasn't a physical pile of cash, lying in the corner. He was referring to something better: an investment opportunity that has a good chance of generating high returns.
These opportunities are rare. And even when the money is "lying in the corner" not everyone sees it.
But if an investor sees it and has no cash to invest, it quickly becomes a missed opportunity. So cash represents potential.
Don't overlook the benefits of cash. Sometimes it is just what a portfolio needs.
Kim Iskyan is the founder of Truewealth Publishing, an independent investment research company based in Singapore. Click here to sign up to receive the Truewealth Asian Investment Daily in your inbox every day, for free.
This article is commentary by an independent contributor.