Is Cash a Smart Investment?

A recent MFS survey found investors, on average, allocated 26 percent of their portfolio to cash.

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If you're tempted to sit out this wild ride in the stock market, you're not alone. A recent MFS Investment Management survey showed investors allocated 26 percent of their portfolio to cash, on average—not through money market funds or certificates of deposit, but savings accounts.

"Across the age cohort, people have decided that they want to have greater access to their money, and it's got to be ATM access," says William Finnegan, senior managing director of U.S. retail marketing for Boston-based MFS. "They want it in the bank."

The survey also found that Generation Y investors (those 18 to 30 years old) allocate even more to cash—30 percent, on average.

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"I think it's probably driven by fear, and it's driven by prior experience," Finnegan says. "When you look at the past decade [when] a lot of these folks came of age in investing—bubbles and bursts, that was their experience." Finnegan blames what many refer to as the "lost decade" for stocks—2000 through 2009—during which the Standard & Poor's 500 index finished in the red.

Overall, nearly 3 in 5 investors cite fear about volatility or needing money someday as a reason for holding high or increasing amounts of cash. Respondents' other top concerns for the next 12 months included rising healthcare costs (78 percent), the growing federal deficit (72 percent), and increases in taxes and legislative gridlock (both 66 percent). A quarter of those surveyed said they liquidated a portion of their portfolio in 2010 or 2011 because of concerns about the market, with 52 percent of Gen Y increasing their portfolio's cash stakes, the most of any age group.

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Despite increased volatility in the stock market (the Dow Jones Industrial Average saw its sixth-worst loss ever on Monday followed by its 10th-largest gain on Tuesday), investors should be wary of being too conservative, which could mean missing out on rallies. "My concern is, 'Are they too conservative, and will they reach their long-term goals?'" Finnegan says.

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Another problem: These days, the return on cash is pennies on the dollar. In December 2008, the Federal Reserve set the federal funds rate at virtually zero, and the Fed has left it there ever since. "Because yields are so low, basically you're getting nothing on cash," says Adam Bold, founder of the Mutual Fund Store, an investment firm based in Overland Park, Kan. For instance, the average 1-year CD yields only 0.87 percent, according to Bankrate.com.

Bold says cash should play a role in almost every investor's portfolio—except for the most aggressive investors—but he generally only allocates up to about 20 percent cash for even his most conservative clients. "I think there's a very high fear factor out there, which is different from the economic reality," Bold says. "Stocks can be moved in the short term by headlines, but after all is said and done, they revert to economic reality, and corporate earnings have been excellent."

Twitter: @benbaden