Do you count cash towards your portfolio asset allocation?

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rca1824
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Do you count cash towards your portfolio asset allocation?

Post by rca1824 »

Like most people, I have 3 main accounts:
(1) A checking account with about 1-3 months expenses.
(2) A savings account with another 3-6 months expense and short-term savings goals.
(3) Investment accounts: SEP + Roth IRAs for everything else. Can't afford a taxable account yet.

When setting my asset allocation, do I count the cash in (1) and (2)? I have 100% equity in (3) but when looking at everything I am closer to 60/40.

But on the other hand, I'm unlikely to rebalance with this money. If stocks fall, I can't just dump my checking account into the market -- I need that cash to pay expenses now. So is it reasonable to the scope of my investment portfolio to (3)?

I also have a fourth category:

(4) Loans - student loans, car loans

Do you count loans towards your asset allocation? Once again I can't rebalance with this money, so it doesn't make sense to add it. Also if I did count loans I would technically be something like 300/-200. In theory I should liquidate the IRA and pay off the loan because I'm technically highly leveraged. But I can't liquidate my IRAs to pay off the loans. Also I feel comfortable being at 300% equity because the loan is being repaid from future income so even if equities fall in value it won't affect my loan repayment as I won't/can't even sell the equities to pay the loan if I wanted to.
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ruralavalon
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Re: Do you count cash towards your portfolio asset allocation?

Post by ruralavalon »

I am 70 years old and retired.

I do not count the checking account (a few months worth of expenses) as part of the investing portfolio. We have no savings account.

Any cash (such as from dividends or interest paid) in our taxable or IRA accounts is considered part of the "bond" allocation.

. . . . .

We have no debt. I would not count debt as part of an asset allocation.

What are the types, amounts and interest rates on the debt? You might be wise to pay off higher interest debti instead of contributing to investing. It depends on a lot of information you have not posted.
Last edited by ruralavalon on Tue Aug 25, 2015 12:39 pm, edited 2 times in total.
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bloom2708
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Re: Do you count cash towards your portfolio asset allocation?

Post by bloom2708 »

I don't count our checking/emergency fund/named accounts (taxes, car, vacation funds) in our AA.

I think you will find that some do and some don't. Other than my 401k, all our investments are at Vanguard. I note that Vanguard let's you set your AA to include stocks/bonds/cash. But the cash is at our local bank. So if I put 5% cash, it has no cash to find at Vanguard.

Does not counting make our 60/40 numbers more conservative? Probably, but that is Ok. I'd say do whatever makes the most sense to you.
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retiredjg
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Re: Do you count cash towards your portfolio asset allocation?

Post by retiredjg »

There is some leeway on how people do this. But generally, you are talking about your retirement portfolio so no, you would not include the money in the other accounts.

I think you are confusing "net worth" with "retirement portfolio".
livesoft
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Re: Do you count cash towards your portfolio asset allocation?

Post by livesoft »

I count all my cash towards my portfolio asset allocation. It is part of the fixed_income/bonds class. I also count it when calculating portfolio performance. Because cash is such a drag, I do not have any savings accounts and I keep my checking account value to about 2 weeks of expenses.

I showed this "cash" in my Portfolio Watch rebalancing thread: viewtopic.php?t=150267
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asif408
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Re: Do you count cash towards your portfolio asset allocation?

Post by asif408 »

I don't count cash in (1) or (2). In fact, the only cash I have in investment accounts are cash turds from my ETF purchases (less than $5.00 right now). To me, cash is money I could need any day. I want it ready to be used if necessary.

If I have any money above what I need for primary spending and emergency money I invest it in stocks or bonds.
knowsnothing
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Re: Do you count cash towards your portfolio asset allocation?

Post by knowsnothing »

Yep - short term reserves and cash has a line for me.
bonaire27
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Re: Do you count cash towards your portfolio asset allocation?

Post by bonaire27 »

I have 2 classes: stocks and fixed (includes all of our cash, bonds, CDs, and pensions).

I think you just need to find what is most comfortable for you.
MathWizard
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Re: Do you count cash towards your portfolio asset allocation?

Post by MathWizard »

No, I don't include the cash equivalents (savings/CDs) that form my first tier EF as part of my AA.

Per your loans:
I think of the payments (of principal) as improving my net worth, so in that sense they are "savings"
(instead of adding a positive, I am subtracting a negative). This may be unique to me, so don't take this as
collective advice from the board, just from me.

I think of it that way so that when the loans are paid off, that money continues to go into the
savings account that it has been automatically paid from, so I don't increase my lifestyle, and consequently
the don't increase the amount I need to save for retirement.

I could pay off the mortgage now, but that is not the best use of my money right now, so this sounds like
your situation. In my way of determining "savings", whether I pay off the house now or not does not
affect my savings rate other than the cost of the interest that I pay, which is offset by the money that
I make in tax-deferred investments.
lack_ey
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Re: Do you count cash towards your portfolio asset allocation?

Post by lack_ey »

I count all assets* and liabilities, though I'm at zero on the latter, with the understanding that many expenses are short term and many are hopefully much longer term. Nobody actually knows for sure when their retirement is going to be (assuming it hasn't happened yet) or if they're going to need the money sooner for whatever reason, so the long term is just an ideal. If an emergency is large enough, maybe it's time to sell stocks.

*for simplification, financial assets and then actual durables that don't depreciate quickly with time, i.e. real estate (though I have zero there too), that would command nontrivial value if sold. "Close enough" usually works.

In my books, everything I don't spend gets saved, and whatever I end up with heading into retirement is my retirement savings. I don't do budgets and just try not to waste money where possible on things that I don't actually find worth it.

Cash in savings and money market accounts now, at the right places (never mind rewards checking, if you do that), has higher rates than short-term Treasuries. It's an investment to me, just with very low volatility and guarantee of principal. Zero-duration bond, if you want to think of it that way.

A loan is not that much different from a negative bond for you, but the terms, rate, and maturity may be different and need different accounting.
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Re: Do you count cash towards your portfolio asset allocation?

Post by mhc »

I count the cash in my checking and savings account. When I retire, I will have money in those accounts and it will be part of my assets. I don't know why I wouldn't include it. My AA is:

80% equities
18.5% bonds
1.5% cash

If I ignored the cash, it wouldn't make much difference. BTW, I don't have loans, so I don't have to worry about how to include them.

I like to include the cash because it shows me when I need to buy more MF's in my taxable account.
52% TSM, 23% TISM, 24.5% TBM, 0.5% cash
ralph124cf
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Re: Do you count cash towards your portfolio asset allocation?

Post by ralph124cf »

I would not count the operating fund (checking) or three to six months of EF in AA, but if you were somebody in retirement keeping three years of expenses in a Money Market fund to avoid selling stocks in a down market, I certainly would count it in the AA.

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Re: Do you count cash towards your portfolio asset allocation?

Post by Grt2bOutdoors »

Cash in my checking, savings or e-fund are off-limits for investing.
Cash in my investment accounts are allocated equities/fixed, very little cash is left un-invested at any one time.
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retiredjg
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Re: Do you count cash towards your portfolio asset allocation?

Post by retiredjg »

Your post asks what other people do and that is what many of them are telling you. But what a person with a large portfolio does is likely to be different from what makes sense for you.
rca1824 wrote:When setting my asset allocation, do I count the cash in (1) and (2)? I have 100% equity in (3) but when looking at everything I am closer to 60/40.

But on the other hand, I'm unlikely to rebalance with this money. If stocks fall, I can't just dump my checking account into the market -- I need that cash to pay expenses now. So is it reasonable to the scope of my investment portfolio to (3)?
The answer to your real question is in these statements.

Your cash is for daily living expenses which obviously is not part of any kind of "portfolio".

Your emergency fund can be part of your portfolio, but does it make sense to do that when your portfolio is so small that the emergency fund actually changes your asset allocation? That makes no sense to me. Later, when you have $300k or so including the emergency fund won't make any difference at all - even when you take some out for an emergency.
inbox788
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Re: Do you count cash towards your portfolio asset allocation?

Post by inbox788 »

rca1824 wrote:When setting my asset allocation, do I count the cash in (1) and (2)? I have 100% equity in (3) but when looking at everything I am closer to 60/40.
Short answer is NO, don't include them. However, I do like to look at what my AA looks like when taking those things into account and your 100% vs 60/40 example is precisely why it's useful to take a look. Did you count your loans as negative bonds? If you subtract out your loans from your cash, what's your adjusted AA now? These numbers are highly variable and not all that meaningful, but give you a bigger picture. Now image 5 years from now when your car loan has been paid off, investment funds are twice the size and cash remains the same. The numbers will all be a lot closer, and comparing differences less meaningful. Additionally, in a few years, you may buy a home and carry a mortgage, and again, the AA will get distorted by whether you count the mortgage or not. You also have to consider whether you consider assets like home or investment property in any sort of AA. Life is complicated, but good problem to have.
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Re: Do you count cash towards your portfolio asset allocation?

Post by alex_686 »

While doing my asset allocation, I count everything as my portfolio: Cash, Social Security, Human Capital, Home Equity, HELOC, home mortgages, auto loans, etc.

I then take all of my goals, required, desired, stretch, contingent.

Then I marry up the portfolio and the goals to get my AA.

Doing it this way let's me run my risk and return holistically and therefore more efficiently. Cash tends to return zilch after inflation so you want to keep that as low as possible. I tend to keep my "emergency cash" in 1. A unused HELOC, 2. Short term bond fund, and 3. Stocks – where the value is given a haircut of 50% when calculating emergency cash needs. Some people might find it needless dangerous to take this type of risk with my emergency funds. However, given the totality of the my situation I need – and have the ability to – to take on that extra risk.
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Re: Do you count cash towards your portfolio asset allocation?

Post by lack_ey »

Part of the issue here is that allocations should frequently not be thought of in percentages, but theory and all the books do it that way in order to generalize so that is what we are used to.

Whether or not you count cash, you have the same amount invested in stocks in hopes of overall assets growing in real purchasing power over the long run. This just needs to be balanced with other needs, including shorter term liquidity. How you handle the bookkeeping and play the odds is up to you.
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Re: Do you count cash towards your portfolio asset allocation?

Post by Ron »

ruralavalon wrote:I am 70 years old and retired.

I do not count the checking account (a few months worth of expenses) as part of the investing portfolio. We have no savings account.

Any cash (such as from dividends or interest paid) in our taxable or IRA accounts is considered part of the "bond" allocation.

. . . . .

We have no debt. I would not count debt as part of an asset allocation.
We do exactly the same thing (except at a much younger age - we're 67 :mrgreen: ).

- Ron
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Re: Do you count cash towards your portfolio asset allocation?

Post by nisiprius »

During the accumulation phase, I counted it if it was in an account where my intention was to hold it for a long time--into retirement.

Checking accounts, buffering the flow of money from paycheck to expenses, didn't count, and neither did savings accounts that were targeted to medium-term purchases (the "car replacement fund,") held as a reserve for semi-predictable life contingencies (house maintenance). Some accounts were ambiguous but I didn't double-count them: if I decided to consider them as part of my "emergency fund" then I didn't allow myself to count them as part of my "retirement savings portfolio" and vice versa.

One of the interesting cultural shifts... in my opinion part of a broad cultural shift toward taking on more and more risks... is that if you check any financial-advice book into the late nineties, they all advised that an investment portfolio including a meaningful cash allocation. The three asset classes were stocks, bonds, and cash (or, if you were highfalutin, equities, fixed income, and short-term reserves). This can be seen with crystal clarity in the makeup of Vanguard's LifeStrategy funds, which until they were revamped in 2011, always had meaningful allocations to "short-term reserves."

I don't think the distinction between bonds and cash matters much; the really critical numbers are "percentage stocks" versus "percentage low-risk assets." For one thing, if you plot mean and standard deviation, I think you'll conclude that the "distance" from cash to (intermediate-term, investment-grade) bonds is much less than the distance between bonds and stocks.
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Re: Do you count cash towards your portfolio asset allocation?

Post by Ron »

All funds held within our respective IRA's (including cash held in our respective settlement/MM accounts) are considered with the bond portion of our portfolio for consideration when measuring holdings vs joint target AA.

All checking/savings (including cash held in a Vanguard Pennsylvania Tax-Exempt Money Market Fund account) outside of our respective IRA's (both TIRA & Roth's) are not considered.

BTW, we're both retired and age 67 FWIW,

- Ron
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Re: Do you count cash towards your portfolio asset allocation?

Post by jimishooch »

emergency fund and/or checking account is not in my AA,
high yield savings account + CDs = fixed income (bonds) are in my AA.
thx
jim
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Re: Do you count cash towards your portfolio asset allocation?

Post by nolapepper »

jimishooch wrote:emergency fund and/or checking account is not in my AA,
high yield savings account + CDs = fixed income (bonds) are in my AA.
thx
jim

same here.
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Re: Do you count cash towards your portfolio asset allocation?

Post by Kevin M »

I personally include all liquid assets in my portfolio, but agree that for a smaller portfolio this may not make sense.

My reward checking account earning 3% is a better investment than any bond fund. Even savings at 1% is about the same as a 3-year Treasury, so call it a short-term Treasury fund with no term risk. So at these rates, the notion of cash drag is poppycock (other than money market funds earning about 0%), as is distinguishing cash from short-term bonds in terms of expected returns.

For a friend who just inherited some money, we set aside certain amounts for taxes, spending, and giving in the next year or two, and that is not included in his portfolio. It was simpler to enter these as negative cash assets in his spreadsheet, so we can just enter cash balances in all savings and checking accounts instead of having a separate account for the expected spending.

Technically a loan is a negative bond, and you clearly understand this; I think most people choose to ignore this. There have been lengthy debates about this here.

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Re: Do you count cash towards your portfolio asset allocation?

Post by Dandy »

I wouldn't count emergency funds or a small amount in a savings account in my investment allocation. They are not intended as investments. Many have a cash or cash-like products as part of their allocation e.g. Savings bonds, money markets, Stable Value Funds, etc.

Your debt is a negative toward your net worth but has nothing to do with your investments.
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Re: Do you count cash towards your portfolio asset allocation?

Post by vitaflo »

For me:

Tax-advantaged: Yes
Taxable: Yes
Emergency Fund Cash: Yes
Extra Savings Cash: Yes
Checking Account Cash: No

When I was starting out (net worth <$500k) I didn't count cash. Now I rope it in with my "bond" allocation since much of it is in tax-exempt muni's.
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Re: Do you count cash towards your portfolio asset allocation?

Post by Stonebr »

nisiprius wrote: One of the interesting cultural shifts... in my opinion part of a broad cultural shift toward taking on more and more risks... is that if you check any financial-advice book into the late nineties, they all advised that an investment portfolio including a meaningful cash allocation. The three asset classes were stocks, bonds, and cash (or, if you were highfalutin, equities, fixed income, and short-term reserves). This can be seen with crystal clarity in the makeup of Vanguard's LifeStrategy funds, which until they were revamped in 2011, always had meaningful allocations to "short-term reserves."
In the past it was easy to have less portfolio risk with a cash allocation because you got paid a decent return -- even in real terms. Perhaps the "cultural shift" had more to do with the drop in yields on cash equivalents rather than taking on more risk. Today MMFs and even online savings accounts yield less than the CPI.
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Re: Do you count cash towards your portfolio asset allocation?

Post by Kevin M »

Dandy wrote: Your debt is a negative toward your net worth but has nothing to do with your investments.
This is one point of view, but definitely not the only one, and in my opinion, not the most rational one: Having a Mortgage and Buying Stocks On Margin:
Your mortgage is a debt, which is the opposite of an asset. Unless you are contemplating a clever move to get rid of it, as a well known financial advisor, book author, and New York Times columnist pulled off (see The Best Way to Lose Your Home and Financial Advisors Support Peer Who Lost His Home), it’s really just a negative bond. As you pay it down, you are making it less negative, which has the same effect as investing in bonds.

As such, it doesn’t make sense to borrow at 4% interest and invest in bonds at 2%.
So debt has a lot to do with your investments and your investment decisions.

Anyone who wants to understand this in more detail also should read the articles linked in tfb's blog post:

Why Is It Risky To Buy Stocks On Margin But Prudent To Buy Them "On Mortgage"? | Kitces.com

MintLife Blog | Personal Finance News & Advice | Paying Down Your Mortgage vs Investing More

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Re: Do you count cash towards your portfolio asset allocation?

Post by Artsdoctor »

Kevin, you just had to sneak in the Kitces articles about getting rid of the mortgage with your investment portfolio, didn't you!

This argument will go on forever, but it does give me pause that the blog was posted in 2011 and if someone would've dumped his entire portfolio then to pay off the mortgage, he would've missed out on huge equity gains in 2013. Of course, 2015 might turn out to be just the opposite.

But the general concept is right. You really need to look at the full balance sheet. Having a ton of cash earning next to nothing when you have a 4% mortgage doesn't make much sense.
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Re: Do you count cash towards your portfolio asset allocation?

Post by Kevin M »

Artsdoctor wrote: This argument will go on forever, but it does give me pause that the blog was posted in 2011 and if someone would've dumped his entire portfolio then to pay off the mortgage, he would've missed out on huge equity gains in 2013. Of course, 2015 might turn out to be just the opposite.
Exactly--we must always be cognizant of hindsight bias, or as Larry Swedroe says, confusing strategy with outcome. Don't want to compare high expected-return, high-risk assets to the guaranteed return of paying down debt; at least realize that the debt essentially is allowing you to invest in risky assets on margin, which also would have worked out great in 2013.

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Re: Do you count cash towards your portfolio asset allocation?

Post by Dandy »

So debt has a lot to do with your investments and your investment decisions

I think we are splitting hairs here. I'm not in favor of much debt - don't have any - paid off my mortgage well before retirement. Don't need much advice on the potential evils of too much debt and debt for the wrong reasons. Sure debt figures into your decisions about investing just like your health and age etc. I just wouldn't make it a formal part of my investment allocation - like actually counting it as a negative bond.

Take your whole life situation into account when deciding if you should invest and if so, your allocation. If you have a lot of the wrong kind of debt maybe you should focus on reducing it vs. investing. Once you decide to invest I don't think you need to tinker with your allocation based on debt changes - unless they are very significant. Your job security, age, health etc seem to be the drivers.
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Re: Do you count cash towards your portfolio asset allocation?

Post by Ron »

Stonebr wrote:Today MMFs and even online savings accounts yield less than the CPI.
But more than recent market returns :? ...

- Ron
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Re: Do you count cash towards your portfolio asset allocation?

Post by bonaire27 »

Ron wrote:
Stonebr wrote:Today MMFs and even online savings accounts yield less than the CPI.
But more than recent market returns :? ...

- Ron
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Re: Do you count cash towards your portfolio asset allocation?

Post by Kevin M »

Ron wrote:
Stonebr wrote:Today MMFs and even online savings accounts yield less than the CPI.
But more than recent market returns :? ...

- Ron
Actually, last I checked annual percent change in CPI had been hovering around 0% year to date, so so far in 2015, online savings account earning 1% has been earning about 1% real, while my I Bonds have been earning 0% nominal and real.

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Re: Do you count cash towards your portfolio asset allocation?

Post by jnet2000 »

No, I do not count 1 & 2 in my asset allocation. I also do not count loans in it too. While I do not have debt, when I did have a mortgage, I counted it on my balance sheet and it effected my net worth but not my asset allocation.
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Re: Do you count cash towards your portfolio asset allocation?

Post by scottj19707 »

rca1824 » Tue Aug 25, 2015 10:24 am

Like most people, I have 3 main accounts:
(1) A checking account with about 1-3 months expenses.
(2) A savings account with another 3-6 months expense and short-term savings goals.
(3) Investment accounts: SEP + Roth IRAs for everything else. Can't afford a taxable account yet.

When setting my asset allocation, do I count the cash in (1) and (2)? I have 100% equity in (3) but when looking at everything I am closer to 60/40.
Hi rca1824,

The broadest (highest-level) break-down I use for my investment portfolio is: 1) equities/stocks, 2) fixed income/bonds, and 3) cash (and cash equivalents).

My #3 would include checking, savings, money market funds, ST receivables, etc.

To me, cash is a bona fide asset class... unto itself... mainly due the "optionality" it provides. I think Mr. Buffett has written some stuff on that point, to that effect.

The last couple of days in the financial markets made me sit up and pay attention, and put some of my cash to work.

Best wishes.
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