Cash Allocations: King or Trash?

This time we look at investor asset allocations, focusing in particular on cash allocations. To build the picture of cash allocations (for US investors) we’ve drawn upon 3 different sources and types of data: the AAII survey (self-reported), implied allocations from ICI mutual fund data (i.e. the ‘market share’ of money market funds), and an aggregate view from the Fed Flow of Funds dataset.

They all say the same thing: investors had been running record/cycle low cash allocations going into 2018. But there’s a few reasons why this is likely to change…

For one, interest rate hikes have started to make cash a more viable asset from an income generation standpoint, so the opportunity cost calculus is progressively shifting as the Fed continues down the rate hike path.

The other thing is that, as always, cash performs a vital task in asset allocation called “capital preservation”. In a world where government bonds look expensive across developed economies, and gold is all over the place, we can have greater confidence that cash will more readily and reliably perform its function of preserving capital in the defensive sleeve.

And of course there is sentiment and market movements. In the absence of constant portfolio re-balancing (i.e. re-balancing back to some pre-determined strategic asset allocation) cash allocations will drift up as a result of market movements in an environment of falling stocks. Likewise on the sentiment front, some investors will be demoralized by falling stock prices and begin to raise cash out of frustration or precaution. We’ve definitely seen this show up in the AAII survey results (the most timely of the 3 indicators).

So with evidently very limited amounts of ‘dry powder’ it’s likely that cash allocations will head higher (at least short term). I think this chart is really an important one to always be watching because the extremes of this chart have basically marked major peaks and troughs of the stockmarket, and indeed should cash allocations rise further it will perhaps ironically raise the odds that stocks go higher as fickle investors get wrong-footed.

If nothing else it’s a good prompt to think about your own cash allocations: the purpose, portfolio rules/policies, and most importantly your process.