Your cash position is not the most exciting or intellectually stimulating asset in your portfolio, but it is still an important component of it.
Cash acts as a buffer
There are two reasons for this. Firstly, cash acts as a buffer between day to day spending and stock holdings. No one wants to have to sell out of a stock which is going well or has yet to fulfill its potential because they need money for an everyday expense.
Companies take time to build their businesses and fulfill their potential. Just look at the charts of some successful blue-chip stocks going back as far as possible and you will see what I mean. This means you need a cash buffer to ensure you can maintain your shareholdings in developing companies in the event of unexpected expenses.
Secondly, the astute investor will have cash ready for when opportunities come along. You do not know when they will come, but will need cash at the ready to take advantage of them.
This requires a disciplined approach and making sure you have saved up that bit extra that can make the difference.
In the article The wealthy don’t need the markets, I explain that astute investors wait until everyone else is panicking and selling, when investor sentiment is low, to invest. They do not need to force money from the market as they have built a buffer of cash and may have different sources of income coming in.
It is wise to direct cash dividends from stocks into a high interest bank account that is separate from your daily use bank account. If possible direct additional savings into this account also, and let these two inputs along with interest build up your cash balance.
Alternatively, Dividend Reinvestment Plans allow you to be paid dividends in the form of additional shares, rather than cash. One advantage of this form of payment is that you don’t pay brokerage on the new shares. If you get paid dividends in cash, however, then you can choose to invest the proceeds where and when you see fit. This is more important when you are starting out and need to build up the number of stocks you have exposure to in order to achieve sufficient diversification.
To direct your dividends into a separate bank account, you need to log into the relevant share registry. The share registry looks after the administration for listed companies’ share registers. You can find which share registry a company uses on its website, or the ASX website.
Although rates are low at present, cash is still an asset and grows with interest payments, so periodically check the interest rate you are getting and see if you can get a higher rate elsewhere. Even if you do not have a large cash holding, having your money work harder, with a higher interest rate, is a good habit to get into and the small percentage increments will add up over the long term.