Blogs & Comment

Asset allocation for 2012: Cash

My first advice for 2012 asset allocation is to hold little or no cash.

In this year’s first column, “Markets: Fourth quarter report,” I laid out the relevant benchmark numbers that allow you to compare how your investment choices performed in 2011 relative to standard investable alternatives. I provide these benchmarks every year because I firmly believe people can become better investors over time even through the briefest of analyses of what they did, and what they might have done differently. It makes you accountable to you, whether you’re a do-it-yourselfer or someone else helps you with your money, because it’s still your money.

For my part, I’m happy with the performance of my own mix of investments this past year. I didn’t make a lot of money, but I did get at least a small positive return from each of the asset classes I own, including equities, which is something given the TSX fell 11.07% last year.

In my opinion, if I can do that in a bad year, I have the right mix of securities. The ‘up’ years will take care of themselves, but I want this mix for the times—and who knows when they’re going to happen?—when the market isn’t so good. Cover the downside, and the upside may not be as great, but I’ll take that to the alternative of big ups and big downs.

Having said that, I will still tactically skew my asset allocation from time to time. If my capital market expectations are for a good bond market and a weak stock market in the next year (such as this year), I don’t necessarily want to change any of the stocks or bonds that I hold. Rather, I’m more likely to skew my asset mix by adding a bond ETF to boost my overall fixed income allocation, and in other years sell it and buy an equity ETF, instead of disturbing the core securities in the portfolio to effect the same thing,

This week I turn the accountability vane directly at myself. In the spirit of ‘what’s good for the goose is good for the gander,’ I’ve already suggested you look over your portfolio for possible improvements. To be fair, I’m going to provide my suggested asset allocation for this year, something else I do every year.

Some regular readers love this feature, because somewhere around June they’ll be able to laugh at how wrong it turned out to be. That’s fair enough: if it’s wrong, it’s wrong. I’d rather it be a bit wrong than not have a view at all. It’s how we all learn.

So here goes. I’ll do cash today, and fixed income and equities next column.

Cash: I divide cash into two component: strategic and tactical. Strategic cash is the amount you hold no matter what part of the market cycle we’re in. It pays for management fees, taxes and other incidentals, and is fed by dividend, interest and distribution payments. On a $100,000 portfolio, 5% or $5,000 in strategic cash should be plenty, especially if you trade less often than you receive dividends, which should be the case.

Tactical cash is extra cash you intentionally hold from time to time either because cash rates are so high that they’re attractive, or because the prospects for bonds and equities are so negative that you’d rather withhold capital from those two asset classes for the time being.

Neither argument holds right now for holding any tactical cash, especially with no reasonable prospects for a near-term rate increase and the yield differential offered by bonds over cash right now.

Bottom line: hold only the barest minimum of cash right now. Use term deposits and GICs instead of money market funds and money market securities such as treasury bills and commercial paper. Go for the term with the highest marginal change in yield.