According to Charles Schwab Corp.’s (SCHW) robo-advisor, Schwab Intelligent Portfolios, an investor’s cash position should be between 6% and 30%, depending on risk appetite and age. If you’re looking for a more specific percentage, many financial experts will tell you to aim for capital allocation of 60% stocks, 30% bonds, and 10% cash. However, investors who are more risk tolerant — those who are younger and who don't necessarily need a fixed income — should have more capital allocated to stocks. (For more, see: Portfolio Management vs. Financial Planning.)

Some of these experts also say that investors in large cash positions are paranoid about a stock market crash. So essentially they're telling you to stay heavily weighted (or become heavily weighted) in stocks.

If you like rants about how what's going on in the macroeconomic sense is likely impact your portfolio, read on. 

Baby Boomer Impact

Keep in mind that many of these pundits/experts have biased interests. Additionally, they feel comfortable offering strategies that pertain to what worked during the massive economic boom we have seen since World War II (despite some hiccups). The primary reason for this overarching boom was the rise of the Baby Boomer generation. When age demographics are that strong, it leads to increased consumer spending, which then drives the economy. (For more, see: Passing Boomers Will Leave a Big Economic Wake.)

However, the analysts you're used to watching and reading are missing the fact that Baby Boomers are now retiring at a pace of 10,000 per day. And this will last for more than a decade. When people retire, their income declines, which means a decline in consumer spending.

This will all tie into your cash position. Please be patient. As far as the economy goes, Baby Boomers are only part of the equation. (For more, see: What's Behind the Sluggish Economic Recovery.)

Federal Reserve vs. Deflation

When the stock market crashed in 2008, it didn’t take long for the Federal Reserve to step in and implement accommodative monetary policies. That’s because for the first time since The Great Depression, deflation reared its ugly head. (Well, it's not that ugly because it is necessary for the long-term health of the economy.) During this very short period of deflation, jobs faded, home prices fell, and prices for goods and services slowly went down. However, it was a very short period of time compared to other financial crises. (For more, see: Understanding Interest Rates.)

With QE and interest rates declining at a rapid rate, stocks became attractive, which lead to investors making boatloads of money. This increased disposable income levels at a time when entitlements were high. These factors combined led to increased consumer spending.

But these trends aren’t sustainable — look at Main Street for the real answer as to how the economy would be performing without Federal Reserve assistance.

Pay attention to the Labor Force Participation Rate, which measures the percentage of Americans either employed or those actively seeking employment. Unlike unemployment rate, the participation rate doesn't include those who have no interest in working. Below is a chart showing the Labor Force Participation Rate in percentage terms since January 2005. The steep decrease is partly due to an aging population, which could lead to a fall in productivity and a decline in GDP growth. 


(Source: U.S. Bureau of Labor Statistics)

Grim Outlook?

Though the timing and magnitude are hard to predict, interest rates will eventually need to rise. This, of course, will lead to a decline in stock prices, especially since those low rates lead to a tremendous amount of debt-fueled growth. But let’s assume that doesn’t happen. The U.S. national debt is $18.2 trillion and counting. In order to help pay off these debts, taxes will need to be raised and entitlements will need to be cut. Neither of these events will be positive developments for the economy. (For related reading, see: How and Why Interest Rates Impact Options.

But once again, let's play devil’s advocate and say this doesn’t happen. It’s not outside the realm of possibility that we take the approach that Japan did in the 1990s and attempt to spend our way out of this mess (that's not a wise choice, by the way). If that happens, then the record low interest-rate environment will have created an asset bubble beyond belief.

Pundits want you to “stay the course” and allocate the majority of your capital to stocks. The industry sees this as correct, but it’s backward looking. If you think there will be another six years of a bull market, then I have a bridge to sell you … a big one! Here’s what’s likely to happen. (For more, see: Deflation and How Central Banks Fight It.)

Deflation Ahead?

Ask yourself this: “If the economy is strong, would central banks around the world need to step in to provide unprecedented support?” You won’t see it right away because central banks around the world have stepped in to help fuel investments and local economies, but much of it is artificial. (For more, see: How Central Banks Control the Money Supply.)

The unfortunate truth is that what was taking place after the market crashed in 2008 was postponed. Eventually, deflation will win. When that happens, prices for goods and services will decline, home values will plummet, and jobs will be scarce. As far as the stock market is concerned, we’re likely to see Dow 8,000 before Dow 20,000. If I’m correct, do you really want the majority of your capital to be allocated to stocks? No. You want to increase your cash position. If you want to earn a little interest, you can put that cash into a savings account or CD. The goal wouldn’t be big gains but capital preservation. (For more, see: Financial Planning: Can You Do It Yourself?)

Not many people can comprehend this because it hasn’t happened in their lifetime. But when there is deflation, your dollars go further because the prices for goods and services decline. Therefore, sitting in cash will not create a cash drag. And if you’re in cash when stocks plunge and if you’re patient, you will have an opportunity to buy stock in high-quality companies at steep discounts. If you’re not sure when that will be, it'll be when people start to say that the stock market is a sham and they will never get involved again. That usually indicates a bottom, but this will be a long time from now. And the rebound will be much slower than last time. It will be normal.

Eventually, the economy will see a real rebound. This will be at least a decade from now, but the U.S. has excellent natural resources as well as the most innovative population on the planet. We will also be energy independent. When we rebound, you don’t want to have a lot of money in cash. That’s when you want to put your money to work, especially in that environment because inflation will be high.

The Bottom Line

Traditionally, you don’t want to hold too much cash in your portfolio. However, this "traditionally” is based on past events. You need to be forward-looking from a macro standpoint, which isn't difficult if you use common sense. In the current environment, you want to consider having more capital allocated to cash than in the past. (For related reading, see: How Much Debt Can You Handle?)

Dan Moskowitz does not have any positions in SCHW. 

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