1. You
2. Advisor
3. Mutual Fund
I always advocate holding cash reserves for unforeseen expenses but some people are extreme. They may keep 3 years worth of expenses in cash for reasons including: the government taking over, bank may go under, China is taking over, don't trust investments, etc. I don't discount anyones fears but I do want to talk it over and see if there are other underlying motivations for keeping extra cash. Maybe they have had a bad experience with debt or growing up they were poor and need extra security. We talk about the likelihood of these scenarios and compromising with 6 to 12 months of cash.
If you have a financial advisor they will have their own fears or strategies that keeps extra cash in your accounts. Maybe they believe the economy is going down or that stocks have risen too much. They can decide to switch out of a certain investment and keep cash for a "better" time or "better" opportunity. To guard against too much cash with an advisor it is good to have an investment plan or policy where the advisor spells out how your money is going to be invested and give target percentages for each investment. Maybe cash can range from 0% up to 5% of your account values in the plan. Whatever it is, make sure you agree to it and that the amount stays within certain parameters.
The area where people are most surprised to find extra cash is with their mutual funds. For the most part, passively managed funds like a S&P 500 ETF or U.S. bond ETF will hold a small fractional amount in cash. However, active managers may be holding 5% or more in cash. They have to keep a certain amount in cash for redemptions from their fund and operations. Managers also have their own fears and strategies for the money they manage and may shift a large amount to cash. This increases your overall amount in cash and the potential returns. One major problem with this flexibility and frequent investment changes is the vast majority of managed mutual funds underperform a comparative index. Just another reason to stick with index funds.
How would have extra cash affected your returns in 2012? In a simple portfolio of 60% S&P 500 and 40% Barclays Aggregate Bond the return in 2012 would have been 11.2%. If, instead, there was 10% in cash, 50% in S&P 500, and 40% in Barclays Aggregate Bond the return was 9.7%.
Cash has its place in every investors financial plan for emergencies and diversification. Make sure you know how much cash you have and that it is not holding you back from building wealth and achieving your long term financial goals.
