In terms of growing wealth, cash is a lousy investment. With inflation running at 2-3% per year, savers making 1% interest on ‘high’ interest savings accounts are effectively losing purchasing power in real terms. You don’t hear of many investors that got wealthy by investing solely in cash.
Having said that, cash can play a vital role when it comes to long-term investing in the stock market. Here’s why.
The key benefit of having cash available on the sidelines is that it gives the investor valuable options.
As private investors, we don’t always need to be fully invested. Whereas many professionals portfolio managers are required to immediately invest capital they receive, private investors have the luxury of being able to wait until attractive opportunities arise. This is a fundamental advantage that private investors have over the professionals and an important investing concept that many investors fail to understand. Waiting for compelling opportunities, as opposed to investing whenever funds are available, can make a big difference to long-term returns.
And this is where cash plays an important role. By having cash available on the sidelines, it allows the investor to take advantage of opportunities when they arise.
Capitalise on higher yields
For example, look at the bargains that were thrown up in the wake of the Brexit vote last June. Many investors were panicking, and many high quality mid-cap stocks were being offered at bargain levels. The investor with cash available can capitalise on this kind of situation whereas the fully invested investor cannot, unless existing holdings are sold.
This is particularly relevant for dividend investors. Waiting for slightly higher yields can make a large difference over the long-term. Therefore if a popular dividend stock looks a little bit expensive right now, there’s no harm at all in waiting for a pull back. In most cases, there will be a good opportunity to buy the stock further down the line.
That’s why, personally, I always try to have a little bit of cash on the sidelines. That way, when opportunities arise, I can take advantage of them.
This article is provided for general information only and is not intended to be investment advice. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.