Joshua Barone
It’s a sad truth of the investment world that some brokers are more interested in generating commissions for themselves than creating profitable growth for their clients.
Even experienced investors, who recognize the divided loyalties of a broker, often struggle with determining whether their broker truly has the client’s best interests at heart. After all, the marketing department of every investment brokerage firm goes to great lengths to spotlight the firm’s total focus on the financial future of its clients.
But there’s a simple test that sheds substantial light on the true motivations of brokers and the firms that employ them:
What do they think about cash? Do they view it as an asset class or a problem?
A broker whose primary interest is generation of commissions almost certainly will view cash as a problem, perhaps offering the deep wisdom, “Cash is trash.”
Cash, after all, doesn’t generate commissions. Cash is not a product that can be sold. Brokerages that are pushing products look at clients’ cash balances as money that is merely waiting to be moved off the sidelines.
Any client who is less than totally invested, after all, might be missing out on the possibility of profit-making trades — and certainly is causing the broker to miss out on commission-generating trades.
Sophisticated investment advisors, the ones who are truly looking after the best interests of their clients, identify cash as an asset class similar to equities, bonds and other categories of investments.
In fact, the first question that a good advisor asks is the amount of cash that a client should have in the portfolio. It’s not an easy question to answer.
Clients themselves may want to minimize the amount of cash in their portfolios. Cash, after all, is boring. No one brags at a cocktail party about the performance of his or her cash.
But cash is an important stabilizer in any investment account. Investors who otherwise are willing to accept a high-risk portfolio, for instance, may want to maintain a relatively large amount of cash on hand simply to cool an otherwise volatile account.
Even portfolios that are filled with seemingly conservative assets — blue-chip bonds, dividend-paying stocks — carry more market risk than many investors recognize.
Many of today’s investors still have nightmarish memories of late 2008 and early 2009 when even conservative portfolios lost 30 or 40 percent of their value in a matter of weeks. Cash, however, didn’t lose its value when most other asset classes collapsed.
Indeed, the right amount of cash in an account can prevent the need to sell long-term investments in bad times. Cash investments provide excellent diversification in an equities-heavy portfolio, even better protection than gold or U.S. Treasury obligations during the last quarter century.
At the same time, cash provides liquid peace of mind — the knowledge that a family has ready resources to meet a financial emergency. Personal finance experts have all sorts of rules of thumb for the “right” amount of cash, but the truth of the matter is that different investors have different cash requirements. Retirees who routinely draw cash to meet regular expenses need a different cash profile than a breadwinner who needs protection from a job loss.
But cash investments aren’t completely free of worry. Returns on cash investments these days are minimal. And, there is always some concern that even modest inflation will erode the value of cash.
So, how much of a portfolio should be devoted to cash investments? The answer varies, depending on the life circumstances of the investor, the investor’s short-term and long-term goals, the amount of risk that’s currently in a portfolio, and the level of risk with which the investor is comfortable.
Note that none of these are questions that can be adequately answered by checking a few boxes on a brokerage firm’s standardized investor profile. They require thoughtful conversation with an advisor who knows how to ask the right questions. They require an advisor with integrity — one who makes sure that an investor keeps just the right amount of cash investment, not too much and not too little, in a portfolio.
Most important, investors always need to recognize that any well-designed portfolio will include some provision for cash as a designated asset class. Cash is not just a place to park money awaiting investment, but a true asset class unto itself.
Those who call themselves investment advisors, but don’t acknowledge the importance of cash investments in a balanced portfolio, may have motivations that are incompatible with their clients’ best interests.
Joshua Barone is a partner with Universal Value Advisors.
