Cash and cash equivalents

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In portfolios, cash and cash equivalents, often shortened to just cash, is one of the three major asset classes, along with equities (including stocks) and fixed income (including bonds). Cash, in common language, means money (currency) in physical form. Cash equivalents are any highly secure financial asset that is liquid, i.e. can be readily converted into cash, such as high-interest savings accounts, short-term Guaranteed Investment Certificate (GICs), money market funds, treasury bills (T-bills), and other debt instruments with less than a year to maturity.

The historical yearly returns of Canadian and US T-bills are available over long periods (see Canadian asset class returns), so in portfolio and asset allocation studies, T-bills are typically used more or less synonymously with cash. In practice, few individual investors actually purchase T-bills, which can have high minimums in brokerage accounts.

This article is concerned with the role of cash in long-term portfolios. During the accumulation stage, the amount of cash recommended by various sources varies from 0 to 10%, with opinions ranging from “cash is trash” to “cash is king”, but the exact proportion of cash versus bonds, in a portfolio dominated by stocks, does not seem critical. During the withdrawal phase, cash can take a greater role in portfolios. For practical ways to park cash, including for emergency funds, see short term cash returns.

Cash as the risk-free asset

In portfolio theory, cash is often considered the "risk-free" asset, whereas stocks and bonds are "risky" assets.[1] A T-bill is a risk-free asset because in nominal (i.e., before inflation) terms, the return is known in advance. Purchase a 3-month Government of Canada T-bill today, and you know exactly how much money you will get back in three months if the federal government is still in business (which seems a near certainty). In other words, T-bills have no interest risk and no credit risk.[2]

Cash as a risky asset

In after-inflation ("real") terms, T-bills are risky (i.e., their return is uncertain), because future inflation is unknown.[3] T-bills historically have had the lowest returns of the three major asset classes (stocks, bonds and cash) over very long periods of time, and the real returns of T-bills are typically very low. So holding cash over several decades creates inflation risk[2], especially in taxable accounts where the real return of cash is likely to be negative. Even before taxes, T-bills had negative real returns during four decades of the 20th century (see Canadian asset class returns).

Role of cash in long-term portfolios

Portfolios designed with retirement as their goal go through an accumulation stage, where assets grow because of new contributions and portfolio returns, and then a withdrawal stage. The importance of cash in such long-term portfolios can vary from no role at all to an important role, especially during the withdrawal stage. In this section we survey model portfolios and benchmarks typically classified as "growth" (with over 60% stocks, the rest in fixed income and maybe some cash), "balanced" (40-60% stocks), and "income" (or "convervative"; less than 40% stocks); the goal of this survey is to visualize the typical ranges of cash allocations. Using the "your age in bonds" rule of thumb, perhaps modified to take pensions into account, the growth and balanced portfolios could be appropriate during the accumulation stage, and the balanced and income portfolios could be appropriate during the withdrawal stage, depending on a number of factors (see retirement planning). In the subsequent sections we discuss specifically the role of cash during the accumulation and withdrawal stages.

Growth portfolios

The following table compiles some model portfolios and benchmarks for investors with over 60% and up to 80% stocks:

Source Investor type Stocks (%) Bonds (%) Cash (%)
Canadian Couch Potato[4] Assertive 75 25 0
Vanguard Canada[5] Moderate growth 80 20 0
Edmond Financial Gp[6] Aggressive 75 25 0
PH&N Investment Serv[7] Growth 75 21 5
CIBC Asset Manag[8] Growth 70 25 5
FPX indexes Growth 70 20 10

Balanced portfolios

The following table compiles some model portfolios and benchmarks for investors with 40-60% stocks:

Source Investor type Stocks (%) Bonds (%) Cash (%)
Canadian Couch Potato[4] Balanced 60 40 0
Canadian Couch Potato[4] Cautious 45 55 0
Vanguard Canada[5] Balanced growth 60 40 0
Vanguard Canada[5] Balanced 40 60 0
Edmond Financial Gp[6] Balanced 55 45 0
Edmond Financial Gp[6] Moderate 40 60 0
PH&N Investment Serv[7] Balanced 60 34 6
PH&N Investment Serv[7] Conservative 40 51 8
CIBC Asset Manag[8] Income & growth 50 40 10
FPX indexes Balanced 50 40 10

Income portfolios

The following table compiles some model portfolios and benchmarks for investors with less than 40% stocks:

Source Investor type Stocks (%) Bonds (%) Cash (%)
Canadian Couch Potato[4] Conservative 30 70 0
Vanguard Canada[5] Moderate 20 80 0
Vanguard Canada[5] Conservative 0 100 0
Edmond Financial Gp[6] Conservative 30 65 5
Edmond Financial Gp[6] Cautious 20 70 10
CIBC Asset Manag[8] Income 35 55 10
CIBC Asset Manag[8] Capital preservation 15 65 20
FPX indexes Income 30 50 20

Cash during the accumulation stage

As shown in the previous section, there is disagreement as to the role of cash during the accumulation stage. Many investors have no cash at all, while others keep 5%, 10% or even more.


The arguments for keeping part of a "growth" or "balanced" long-term portfolio in cash lie in two groups, tactical and strategic. The tactical argument is that a cash reserve constitutes "dry powder" in case stocks become cheap.[9] This is not compatible with strategic asset allocation, and it could be difficult to know exactly when use the "dry powder". In other words, this is a form of market timing, and there is ample evidence that market timing does not work on the aggregate.

Strategic arguments for cash would be to "serve as a stabilizer"[2] or portfolio diversifier[9] for growth or balanced portfolios. Cash can reduce the portfolio volatility and reduce downside risk, since this asset class has positive nominal returns, a low standard deviation of returns, and a correlation with stocks typically close to zero.[8] Keeping a constant allocation to cash could also have behavioural benefits: "having a cushion of cash can help you stay invested when stocks tumble – as they surely will sooner or later."[10]

The combination of 20% broad-market bonds and 10% cash in the FPX Growth index could perhaps be replaced by 15% short bonds and 15% broad-market bonds, a mix which should behave similarly.[11]


During the accumulation stage, cash can be seen as a drag on returns, especially in a low interest rate environment. There is no need for liquidity in a long-term portfolio during the accumulation stage, so why include an asset class with such low returns? This does not mean that the investor does not have cash reserves elsewhere to face short term needs (see emergency fund), but this is separate from the long-term portfolio.

Will it make a big difference?

For a portfolio with 40 to 80% stocks, will replacing some bonds by cash (as done in the FPX indices for example) really make a difference? The following graph says no... But the "cash question" becomes much more important at low stock allocations.

Hypothetical mixes, in 10% increments, of 3-month T-bills and stocks (lozenges), as well as 10 year Govt. of Canada bonds and stocks (circles). The bold curve mixes stocks, in 10% increments, with a half-and-half combination of T-bills and bonds (Xs, 0-30% stocks shown only for clarity). Coloured squares show the three FPX indices. Nominal annualized asset class returns assumed to be 3-month T-bill, 0.6% (Bank of Canada, 2015-01-27); 10 year bond, 1.4% (Bank of Canada, 2015-01-27); stock, 7% (we can hope!). Standard deviations: 3-month T-bill, 2%; bond, 6%; stock, 17% (corresponds approximately to the 1993-2013 Libra data for 3-month T-bills, all Canadian bonds, and S&P/TSX Comp). Correlations: bill-bond 0.37; bill-stock 0.05; bond-stock 0.07 (1993-2013 Libra data).

Withdrawal stage

Cash typically takes on a larger role in portfolios during the withdrawal stage. Here the idea is to offer protection from stock (or bond) market downturns: retirees are told to have a "large enough commitment to low-risk liquid cash assets so that you are not forced to sell stocks or longer-term fixed-income assets during a protracted market downturn".[2]

For example, if you want to protect your longer-term assets from forced sales over a five-year period (roughly, a full market cycle), and you plan on withdrawing 4% of your investment portfolio in your first year of retirement for income, you would want to allocate at least 20% of your investment portfolio to low-risk liquid cash assets.

— Investor Professor, The Role of Risk-Free Assets in Your Long-Term Portfolio, AAII Journal, April 2009


  1. A. Shapiro, Asset Allocation: Risky vs. Riskless, New York University, Leonard N. Stern School of Business, lecture notes for "Foundations of Finance", Fall 2013, viewed January 31, 2015 -- the syllabus is here
  2. 2.0 2.1 2.2 2.3 The Role of Risk-Free Assets in Your Long-Term Portfolio, AAII Journal, April 2009, viewed January 28, 2015
  3. N. Canner et al., An asset allocation puzzle, National Bureau of Economic Research, Working Paper No. 4857, September 1994, DOI 10.3386/w4857, viewed January 28, 2015
  4. 4.0 4.1 4.2 4.3 Couch Potato model portfolios, viewed January 31, 2015
  5. 5.0 5.1 5.2 5.3 5.4 Vanguard, Vanguard Quarterly - A guide to our ETFs and portfolio strategies in Canada, October 2014, viewed January 28, 2015; readers should note that Vanguard Canada does not offer ETFs covering money markets, so it not surprising that they allocate 0% to cash in all their model portfolios, even for conser vative investors
  6. 6.0 6.1 6.2 6.3 6.4 Edmond Financial Group, Portfolio Profiles, viewed January 28, 2015 – the “registered” version is tabulated
  7. 7.0 7.1 7.2 PH&N Investment Services model portfolios, viewed January 30, 2015; percentages may not add up to 100% due to rounding
  8. 8.0 8.1 8.2 8.3 8.4 G.G. Dallal, Long-Term Strategic Asset Allocation, CIBC Asset Management, 2013, viewed January 30, 2015; in the tables, the version with global equities included in the portfolios was used; their recommendations were unchanged for 2014
  9. 9.0 9.1 PIMCO, The Role of Cash in Multi-Asset Portfolios, June 2013, viewed January 28, 2015
  10. J. Zweig, A Few Good Reasons to Hoard Some Cash Now, The Wall Street Journal,(subscription required) November 8, 2013, viewed January 28, 2015
  11. This is based on the weighted average maturities of cash (assumed to be 0.5 years), short bonds (about 3 years based on XSB in January 2015) and broad market bonds (a little over 10 years based on XBB)

Further reading

External links