Staying in cash comes with its own risks, which a diversified approach can help mitigate
- Even though cash is now yielding a higher return, it is not a riskless investment choice. Keeping all or most of a portfolio in cash can introduce investors to other types of unintended risks.
- Those risks can include reinvestment risk in the face of declining rates, decaying purchasing power through stickier inflation, and the opportunity costs of missing the higher return potential of a diversified stock/bond portfolio. But the biggest risk of all is not being able to achieve the goals of one’s financial plan.
- To have cash or not to have cash shouldn’t be an all or none question. Instead, employing an approach to diversify a portfolio across various investments, including some cash, can help mitigate these risks.
As we approach the end of the fastest interest rate hiking cycle by the Federal Reserve (Fed) in 40 years, yields on cash and cash equivalents are now offering attractive returns that haven’t been seen in over 15 years. Given these elevated yields and the memory of 2022’s volatile market, investors might be tempted to keep higher-than-normal cash levels and earn that income. However, keeping a large amount of one’s investment assets in cash introduces its own set of risks that investors should consider, including reinvestment risk, purchasing power risk, and opportunity cost.
1) Reinvestment risk
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