The Role of Risk-Free Assets in Your Long-Term Portfolio
What is a risk-free asset, and what role should it play in your portfolio?
That’s one of the first questions many investors ask when struggling with the asset allocation question.
In this article
- What Asset Is Risk-Free?
- No Such Thing as No Risk
- Putting It Into Perspective
- Spending & Emergencies
- Tempering Volatility
- Cash Benefits
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In today’s market environment, the sudden and steep drop in the stock market as well as anxiety over the future of the banking industry and the financial health of long-term bond issuers have all caused a massive rush to—and an exclusive focus on—“risk-free” assets.
Yet only two years ago, these assets appeared “boring” to many investors who—at that time—were focused on the long-term return and current income attributes of the major asset classes (stocks, bonds and cash).
But neither of those perspectives produces a useful guideline. Instead, the role these assets play in your portfolio should be based on a perspective that encompasses both long-term and short-term considerations.
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Discussion
Bills, notes, bonds--include in that zero coupon bonds, when held to maturity, and laddered, can provide some security in terms of return to your portfolio. Changes in interest rates can affect the value of what you get on the return, but the investor has a set rate of return, unlike stocks. This makes for a more predictable part of the portfolio. I'm hoping that, like stocks (through direct purchase, funds and ETFs), this market will become more easy for the individual retail investor to participate in both on a cost basis and as far as access to information is concerned. Time will tell.
posted about 1 year ago by John from Nebraska
I have about 18% of my investments in cash and very short term bond funds. I am worried about interest rate risk, and the role of these investments is to reduce my fixed income investment duration. I feel there are additional risks to cash as an investment. First, in cash form, it is more likely to be spent! Second, it does not keep up with inflation (effectively looses one of two percent in purchasing power per year). Personally, I don't like cash at all, and have it only because of my concerns about the probability of rising interest rates, which cause long duration bonds to significantly loose value.
posted about 1 year ago by Jim from California
In these uncertain times having a cash of 30% is safer. We want higher returns but our economy is fragile. we (USA) are broke and so is Europe.
If austerity is imposed, we might see another deep recession. Japan is suffering from deflation for over 20 years. And no end in sight.
Unless the super-rich are willing to pay their due share of taxes, we can end up less money in the hands of middle class. If people stop investing in the stock market, billionaires cannot make money through the Wall Street gimmicks like derivatives and hedge funds. We are at the mercy of the supr-rich. It is a gambling casino for many of us.
My suggestion is play safe.
posted about 1 year ago by Santosh from California
I keep three years of cash on hand, either cash or very short term bonds. If at the end or even during the year if we have experienced a up tick I will take out another year. If there is a down turn in the market I can sit on the side for three years if needed.
posted about 1 year ago by Paul from California
We're holding 2 years of cash and $186,000) in I bonds. ( Purchased in 2001.)
posted about 1 year ago by Joan from California
There was a book titled "Buckets of Money" that has provided me with my retirement allocation plan
o Bucket One had 5 years of cash and short term bonds
o Bucket Two had 5 years of longer term bonds
o Bucket Three had the remainder in equities
The approach then called for me to spend Bucket One money down over the next 5 years (this allows the other Buckets to grow and avoids selling equities during market downturns) and then you redistribute or refill the buckets a the end of 5 year.
posted about 1 year ago by Charles from Louisiana
I'm retired and keep a two and a half year supply of money on hand at all times. Every four to six months I replenish it regardless of what the market is doing.
posted about 1 year ago by Jack from California
I keep 2 years in cash and 305 invested in income and short term funds. The rest is in ETF's that will go south for 3 years only if the world ends financially.
posted about 1 year ago by John from Michigan
I used to keep one year of cash but now have seven, which is too much. It amounts to 20% of my portfolio. There's so much uncertainty now I'm reluctant to be fully invested, but real inflation is killing me.
posted about 1 year ago by Judith from Ohio
I think that if you have pension, social security, and investment income that covers living expenses, then there is little need for large cash reserves. As a 80 year old retiree I have 60% in fixed income (bonds), 30% in dividend paying stock, and the balance in a govt money market fund.
I use my cash reserve to fund my "rounds of pleasure".
posted about 1 year ago by Paul from Michigan
