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Balancing Equity Risk: Is Cash King Today?

If rates are set rise, some investors wonder if cash is a better bet than bonds in a balanced portfolio. 

Karen Wallace 11 August, 2015 | 17:13
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Question: Can I use cash to provide diversification for the stocks I hold in my portfolio? With rising rates, it doesn't look like a great time to buy bonds. 

Answer: The short answer is that cash can help offset one's equity risk. As you allude to in your question, cash won't lose ground during an equity downturn; nor will your cash depreciate in the event that rates move higher. But depending on your time horizon, bonds may be a better choice, especially when factoring in inflation. 

Your Time Horizon
Right off the bat, there are a few unknowns that make this a tough question to answer. For one, everyone's investing situation is a little different. The "right" asset allocation depends on an investor's time horizon and risk capacity. For instance, an investor who will need funds in the very near term might be better off holding cash or a cash-equivalent investment. Although yields on savings accounts at major U.S. banks (so-called brick-and-mortar banks) are pretty miserly at the moment, some online banks (which do not have to bear the expense of managing branches, paying tellers, and so on) can offer rates close to 1%, and many times they also offer higher rates for money market accounts or certificates of deposit. Given that high-quality short-term bonds have yields that are barely higher than that, it's hard to justify the potential for principal volatility that can come along with bonds if your time horizon is very short. 

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About Author

Karen Wallace  Karen Wallace, CFP® is Morningstar’s director of investor education.

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