Investors hold cash for a number of different reasons, such as for short-term liquidity needs, capital preservation, and when they’re concerned about the impact that market volatility may have on their portfolios. Depending on the reason, holding the bulk of their cash allocation in traditional cash instruments may not be the best option for investors.
A liquidity tiering strategy may help investors gauge how much cash they may actually need in their portfolios based on their goals and objectives, and how much they should consider allocating to higher-returning short duration strategies.
What this chart shows
Many investors hold more cash than they may need to meet their objectives. Shaped like a funnel, the liquidity tiering strategy below highlights the allocation building blocks and the approximate size of each depending on their goals and objectives. Tier 1, at the bottom, tends to be the smallest and is generally reserved for immediate cash needs and daily expenditures, while the larger Tier II can be used as a semi-permanent asset allocation; here, investors may consider actively managed short-term strategies to enhance their return potential versus traditional cash strategies. Finally, Tier III is often the largest of the three: Dedicated return drivers, like core bond funds, can help investors seek to outpace inflation and preserve purchasing power over the long-term. Both Tier II and Tier III come with an escalating modest degree of additional risk versus traditional cash investments.
What it means for investors
Volatility can be worrisome, but rather than sitting on the side lines by over-allocating to cash, consider moving slightly up the risk-reward spectrum with a tiered approach. Allocating to diversified, actively-managed short-term bond strategies in Tier II can help investors enhance return potential while still maintaining an attractive liquidity profile. And sticking with return drivers in Tier III, such as actively managed core bond strategies with a global opportunity set, can help diversify equity risk and potentially generate the returns needed for longer-term spending needs.