Recently, clients have asked why we have so much cash in our portfolios. Our portfolios are usually going to be a mixture of stocks, bonds and cash. The more aggressive the portfolio, the greater our allocation to stocks. Until recently, stocks have outperformed both bonds and cash. Except for our all-equity portfolio, all of our clients will hold some bonds or bond funds. Bonds have performed well over the past thirty years or so as interest rates have decreased but have not done well recently. The Bloomberg U.S. Aggregate Bond Index is down almost three percent for the year ending January 31, 2022. The funds we tend to use in account have fared better but it is because of the yield. Also these bond funds hold large cash positions. Their principal losses more than offset the interest the funds have earned so there is still an overall loss in bond investments. Bond prices have been declining and these declines are generally driven by arithmetic. When interest rates increase, bond values will decrease and when interest rates decline, bond values will increase. With interest rates near historic lows, there is only one way for future rates to go and that is up. There is also concern that the Federal Reserve will increase interest rates in 2022 in order to combat inflation. How many times and by how much is still under discussion but the fear is that the Fed will be aggressive since they may not have been aggressive enough recently. This uncertainty is also leading to the decline in bond values. Our portfolios have held as much as twenty percent in cash. Some of this cash is the result of asset sales in December. Some of this is being used as a bond substitute. Cash or money market investments are essentially returning zero. However, zero return is better than minus three. Cash in the long run should not be used for investment purposes but in the short or intermediate term cash can be strategically deployed to reduce volatility and losses. Unless you have a large cash position outside of what we manage, higher levels of cash can be a valuable investment tool. One of the tenets of investing is to avoid losing money. While there is no guarantee that losses can always be avoided, zero return beats minus three every time.

James J. Denora, CPA, CFP®

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