## The cost of excess cash in portfolio

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1210sda
Posts: 1416
Joined: Wed Feb 28, 2007 8:31 am

### The cost of excess cash in portfolio

Just doodling around with some numbers. Does this seem sound? I'm trying to calculate the "cost" of having a larger Cash allocation.(Using my assumptions, of course).

Assumptions:
Portfolio: \$1,000,000
Residual Living Expenses(RLE): 25,000 per year
Asset Allocation: 60/40 (Stocks/Bonds)
Retired

Expected Total Return:
Cash 1.3%
Bonds 2.6%
Stocks 7.5%

Example 1.
Cash \$25,000 x 1.3% = \$325
Bonds \$375,000 x 2.6% = \$9,750
Stocks \$600,000 X 7.5% =\$45,000
Total \$1,000,000 x 5.51% = \$55,075

Example 2.
Cash \$100,000 x 1.3% = \$1,300
Bonds \$300,000 x 2.6% = \$7,800
Stocks \$600,000 X 7.5% =\$45,000
Total \$1,000,000 x 5.41% = \$54,100

In Example 1, you have \$25,000 in Cash which is equal to 1 year's RLE. In Example 2, you increase your Cash to cover 4 year's of RLE This was done by increasing Cash by \$75,000 and decreasing Bonds by the same \$75,000. Stocks stay the same.

Portfolio 1 with the smaller allocation to Cash has a total return of 5.51% (\$55,075) and Portfolio 2 with the larger allocation to Cash has a total return of 5.41% (\$54,100)

So, in this example, the annual "cost" of the additional cash is 0.10%. (\$975)

In my real portfolio I'm somewhat heavy in cash. I'm just trying to make myself feel good by saying that the "cost" of the additional security of the extra cash is minimal.

1210

PFInterest
Posts: 2684
Joined: Sun Jan 08, 2017 12:25 pm

### Re: The cost of excess cash in portfolio

cash is a drag.
it drags more when the market is on a tear (my cash missed out on 26% in intl so far this year....)
but it lifts when the market tanks (my cash from 2008-09 made a killing).

rocket354
Posts: 208
Joined: Mon Dec 14, 2015 12:31 pm

### Re: The cost of excess cash in portfolio

Cash is a drag. You don't have to jump through all those hoops to come to how much it's costing you.

The opportunity cost, per year, is (alternative investment return - return on cash)*amount in cash.

Using your numbers, you switched \$75,000 between bonds at 2.6% and cash at 1.3%. (2.6% - 1.3%)*\$75,000 = \$975, the number you got.

However, that is not the whole story. You chose to compare some of your cash against your next-lowest-expected-return asset. You really have \$100,000 in cash, and could, for example, compare it against stocks. Again, using your numbers (7.5% - 1.3%)*\$100,000 = \$6200. That's a bit more.

In addition, that difference compounds. Just like expense ratios, that 6.2% compounds over time. To give an example over 30 years:

\$100,000 at 1.3% for 30 years becomes: \$147,327
\$100,000 at 7.5% for 30 years becomes: \$875,495

For a difference of \$728,168. That makes cash VERY expensive. Of course, none of us know what will happen, and everyone's comfort level is different. But, personally, I keep some working amount in my 2% checking account, and the rest is invested.

WanderingDoc
Posts: 1280
Joined: Sat Aug 05, 2017 8:21 pm

### Re: The cost of excess cash in portfolio

rocket354 wrote:
Tue Dec 19, 2017 12:59 pm
Cash is a drag. You don't have to jump through all those hoops to come to how much it's costing you.

The opportunity cost, per year, is (alternative investment return - return on cash)*amount in cash.

Using your numbers, you switched \$75,000 between bonds at 2.6% and cash at 1.3%. (2.6% - 1.3%)*\$75,000 = \$975, the number you got.

However, that is not the whole story. You chose to compare some of your cash against your next-lowest-expected-return asset. You really have \$100,000 in cash, and could, for example, compare it against stocks. Again, using your numbers (7.5% - 1.3%)*\$100,000 = \$6200. That's a bit more.

In addition, that difference compounds. Just like expense ratios, that 6.2% compounds over time. To give an example over 30 years:

\$100,000 at 1.3% for 30 years becomes: \$147,327
\$100,000 at 7.5% for 30 years becomes: \$875,495

For a difference of \$728,168. That makes cash VERY expensive. Of course, none of us know what will happen, and everyone's comfort level is different. But, personally, I keep some working amount in my 2% checking account, and the rest is invested.
Being liquid is very important to a lot of people, depending on what you invest in. Institutional investors, Entrepreneurs, Real estate investors should (and do) hold a lot of cash. I always hold \$100-150K of cash so I can hop on the next real estate opportunity. I don't mind missing out on 7% mutual fund returns, since my leveraged real estate holdings routinely have returned 30-40%. The only mistake was holding the cash in a 0.2% interest account, am now in the process of moving this to Ally CDs and savings
I'm not looking to get rich quick (stocks), I'm not looking to get rich slow (indexing), I'm looking to get rich, for sure (real estate) | Don't wait to buy real estate. Buy real estate.. and wait.

rocket354
Posts: 208
Joined: Mon Dec 14, 2015 12:31 pm

### Re: The cost of excess cash in portfolio

WanderingDoc wrote:
Tue Dec 19, 2017 1:08 pm
rocket354 wrote:
Tue Dec 19, 2017 12:59 pm
Cash is a drag. You don't have to jump through all those hoops to come to how much it's costing you.

The opportunity cost, per year, is (alternative investment return - return on cash)*amount in cash.

Using your numbers, you switched \$75,000 between bonds at 2.6% and cash at 1.3%. (2.6% - 1.3%)*\$75,000 = \$975, the number you got.

However, that is not the whole story. You chose to compare some of your cash against your next-lowest-expected-return asset. You really have \$100,000 in cash, and could, for example, compare it against stocks. Again, using your numbers (7.5% - 1.3%)*\$100,000 = \$6200. That's a bit more.

In addition, that difference compounds. Just like expense ratios, that 6.2% compounds over time. To give an example over 30 years:

\$100,000 at 1.3% for 30 years becomes: \$147,327
\$100,000 at 7.5% for 30 years becomes: \$875,495

For a difference of \$728,168. That makes cash VERY expensive. Of course, none of us know what will happen, and everyone's comfort level is different. But, personally, I keep some working amount in my 2% checking account, and the rest is invested.
Being liquid is very important to a lot of people, depending on what you invest in. Institutional investors, Entrepreneurs, Real estate investors should (and do) hold a lot of cash. I always hold \$100-150K of cash so I can hop on the next real estate opportunity. I don't mind missing out on 7% mutual fund returns, since my leveraged real estate holdings routinely have returned 30-40%. The only mistake was holding the cash in a 0.2% interest account, am now in the process of moving this to Ally CDs and savings
While I agree completely, I would say that the investors in your example are not comparing cash with stocks. They are comparing their part-time (at least) job as an investor to stocks, and concluding that their investor-job returns are preferable to their stock returns. Thus, it's the same calculation but with different expected return values.

Passive investors are more often comparing cash vs stocks directly, in which case it's helpful to know what it is costing and then making the allocation decision based on their comfort level.

Just out of curiosity, do real estate deals come together so quickly that someone couldn't take a few days to cash out some from an index fund?

WanderingDoc
Posts: 1280
Joined: Sat Aug 05, 2017 8:21 pm

### Re: The cost of excess cash in portfolio

rocket354 wrote:
Tue Dec 19, 2017 1:19 pm
WanderingDoc wrote:
Tue Dec 19, 2017 1:08 pm
rocket354 wrote:
Tue Dec 19, 2017 12:59 pm
Cash is a drag. You don't have to jump through all those hoops to come to how much it's costing you.

The opportunity cost, per year, is (alternative investment return - return on cash)*amount in cash.

Using your numbers, you switched \$75,000 between bonds at 2.6% and cash at 1.3%. (2.6% - 1.3%)*\$75,000 = \$975, the number you got.

However, that is not the whole story. You chose to compare some of your cash against your next-lowest-expected-return asset. You really have \$100,000 in cash, and could, for example, compare it against stocks. Again, using your numbers (7.5% - 1.3%)*\$100,000 = \$6200. That's a bit more.

In addition, that difference compounds. Just like expense ratios, that 6.2% compounds over time. To give an example over 30 years:

\$100,000 at 1.3% for 30 years becomes: \$147,327
\$100,000 at 7.5% for 30 years becomes: \$875,495

For a difference of \$728,168. That makes cash VERY expensive. Of course, none of us know what will happen, and everyone's comfort level is different. But, personally, I keep some working amount in my 2% checking account, and the rest is invested.
Being liquid is very important to a lot of people, depending on what you invest in. Institutional investors, Entrepreneurs, Real estate investors should (and do) hold a lot of cash. I always hold \$100-150K of cash so I can hop on the next real estate opportunity. I don't mind missing out on 7% mutual fund returns, since my leveraged real estate holdings routinely have returned 30-40%. The only mistake was holding the cash in a 0.2% interest account, am now in the process of moving this to Ally CDs and savings
While I agree completely, I would say that the investors in your example are not comparing cash with stocks. They are comparing their part-time (at least) job as an investor to stocks, and concluding that their investor-job returns are preferable to their stock returns. Thus, it's the same calculation but with different expected return values.

Passive investors are more often comparing cash vs stocks directly, in which case it's helpful to know what it is costing and then making the allocation decision based on their comfort level.

Just out of curiosity, do real estate deals come together so quickly that someone couldn't take a few days to cash out some from an index fund?
My experience is, most folks spend time on what they like. Even if mutual fund investing is "passive", reading and talking about it, thinking about it, is not. I spend approx. 2-3 hours per month on my real estate business in aggregate. I also spend 5-6 hours a month on this "mutual funds forum". These are just facts.

Its because money invested in mutual funds is often stuck. From what I gathered on here, most folks keep ~50-75%++ of their investments in tax-advantaged accounts, making them effectively useless throughout most of the investors lifetime. Even in a taxable account, I don't feel like holding money in there, and then paying 30%+ in taxes on it before doing a real estate deal. I guess that is why most people don't recommend to invest ANY money in equities that you don't plan to hold for 5-10 years or more.

For the really good deals, you need cash within 1-2 days notice or less, for a decent deal within 2 weeks or less.
I'm not looking to get rich quick (stocks), I'm not looking to get rich slow (indexing), I'm looking to get rich, for sure (real estate) | Don't wait to buy real estate. Buy real estate.. and wait.

1210sda
Posts: 1416
Joined: Wed Feb 28, 2007 8:31 am

### Re: The cost of excess cash in portfolio

rocket354 wrote:
Tue Dec 19, 2017 12:59 pm
However, that is not the whole story. You chose to compare some of your cash against your next-lowest-expected-return asset. You really have \$100,000 in cash, and could, for example, compare it against stocks.
\$100,000 at 7.5% for 30 years becomes: \$875,495
Thank you for the response.

To clarify, I did not compare cash to the next lowest expected return asset.

I compared the entire portfolio return in Example 1 to the entire portfolio return in Example 2. I was not comparing one asset class to another.

The asset allocation in portfolio 1 was 60%/37.5%/2.5% (Stocks/Bonds/Cash)
The asset allocation in portfolio 2 was 60%/30%/10% (Stocks/Bonds/Cash)

I was trying to maintain the approximate risk profile of the portfolio at 60/40. I suppose if I wanted to offset the cash drag, I could do so by adjusting the AA to 63.25% Stocks/26.75% Bonds/ 10% Cash = 100%

That would probably impact the Standard Deviation. Hmmm, maybe that's another for me to look at it. How much increase in standard deviation would result from adjusting the AA so as to eliminate the cash drag. (caused by going from \$25,000 to \$100,000).
1210

rocket354
Posts: 208
Joined: Mon Dec 14, 2015 12:31 pm

### Re: The cost of excess cash in portfolio

1210sda wrote:
Tue Dec 19, 2017 1:45 pm
rocket354 wrote:
Tue Dec 19, 2017 12:59 pm
However, that is not the whole story. You chose to compare some of your cash against your next-lowest-expected-return asset. You really have \$100,000 in cash, and could, for example, compare it against stocks.
\$100,000 at 7.5% for 30 years becomes: \$875,495
Thank you for the response.

To clarify, I did not compare cash to the next lowest expected return asset.

I compared the entire portfolio return in Example 1 to the entire portfolio return in Example 2. I was not comparing one asset class to another.

The asset allocation in portfolio 1 was 60%/37.5%/2.5% (Stocks/Bonds/Cash)
The asset allocation in portfolio 2 was 60%/30%/10% (Stocks/Bonds/Cash)

I was trying to maintain the approximate risk profile of the portfolio at 60/40. I suppose if I wanted to offset the cash drag, I could do so by adjusting the AA to 63.25% Stocks/26.75% Bonds/ 10% Cash = 100%

That would probably impact the Standard Deviation. Hmmm, maybe that's another for me to look at it. How much increase in standard deviation would result from adjusting the AA so as to eliminate the cash drag. (caused by going from \$25,000 to \$100,000).
1210
My apologies if I explained poorly.

You moved your assets from cash to bonds. Thus, that's the difference in the returns you see: you're comparing your return with your current allocation to one that has the cash moved to bonds. Mathematically, it doesn't matter what else is in your portfolio: the entirety of the difference you see in your returns is going to be from the amount you moved from cash to whatever other investment you choose. Those are the numbers I ran through as examples, using your assumptions.

Best of luck with your allocation decision.

123
Posts: 3900
Joined: Fri Oct 12, 2012 3:55 pm

### Re: The cost of excess cash in portfolio

If you have a large cash position in a taxable account that kind of bothers you or you feel guilty about there is a simple way of dealing with it. One can simply buy (short term) Treasury securities (even 4 week bills) they are unlikely to fluctuate much and settlement is two days after sale if I remember correctly. If you have just a regular taxable brokerage account you can change it to a margin account. The margin account doesn't cost anything until you actually "use" some of the margin. The margin feature will allow you immediate cash if and when you need it, if you hold securities you would intend to sell immediately to raise cash, like Treasuries, you would only pay margin interest/fees for a couple of days if you're diligent about it. As long as you don't anticipate over-extending yourself with a margin feature on a brokerage account to me it's a no-brainer. Just like having credit cards or other lines of credit so you don't have to carry a wad of cash with you all the time.
The closest helping hand is at the end of your own arm.