Is 10% Cash Enough? Navigating Market Swings with Smart Strategy

I recently heard a stock market veteran recommend minimum 10% allocation to cash at all times in an interview.

His rationale?

Well, he had seen the brutal 2008 stock market crash first hand but was unable to take advantage of the bear market as he did not have any cash in his portfolio.

So, it has been his mantra ever since that he has at least 10% cash in his portfolio at all times.

What about you?

How much minimum cash do you have in your portfolio at all times? Do you like it to be much higher than 10% or do you not like cash at all and prefer being 100% invested in equities all the time?

Well, there are experts who warn you not to be heavily into cash and recommend being as much in equities as possible. They argue that stock market returns are quite lopsided.

Hence, if you stay out or have a large allocation to cash, then you risk missing some of the best days in the stock market and this can prove quite detrimental to your long-term returns from stocks.

I had done a study back in 2021 to analyse the impact of missing the best 25 days in the stock market over the last 30 years. And the results were quite surprising.

If you had missed the best 25 days in the stock market, a 40x return from the Sensex would have fallen to a mere 5x. Yes, that's true.

If you had pulled out money from stocks just the day before it had a strong up move and reinvested it back immediately the next day and did this for the 25 best days, your long-term returns from stocks would have been very, very poor.

This is the reason a lot of the experts advise you against having a large allocation to cash because even if you miss out few best days, the long-term repercussions on your returns are huge.

Now, while this advice does look like a sound one, it fails to consider the other side of the equation. What happens if you miss the 25 worst days in the stock market? By how much do your returns go up? Well, even here, the results are quite shocking.

If you had missed the 25 worst days in the stock market, your returns from the Sensex would have jumped from 40x to a whopping 300x.

Yes, you read that right. By missing the 25 worst days, you would have seen a 7.5x improvement in your returns and this is quite staggering to be honest.

This does muddy the waters a little bit, doesn't it?

Holding on to a sizeable amount of cash does not seem all that bad after all. Especially, if that allows you to miss some of the worst days in the stock market.

Supporters of the 'you should always hold some cash' theory also point to Warren Buffett's huge cash surplus at all times to further buttress their argument.

In fact, even now, Buffett is sitting on a huge cash pile of more than US$ 350 bn in his investment vehicle, Berkshire Hathaway.

However, it is worth highlighting that Buffett runs a huge insurance operation and, in this business, cash is more a necessity than an optionality.

Yes, he has often admitted to holding on to more cash than is required by the business but his investment style, the enormity of his business and his ultra long holding periods, does not make him directly comparable to small investors like us.

Seth Klarman is another investor who always likes to hold a certain minimum percentage in cash and also has a more conventional set up for managing money, making him a much closer comparable to us than the Oracle of Omaha.

So, why does Klarman hold such a significant percentage in cash at all times?

It's because he believes that if there are no opportunities, one has to be in cash instead of buying a substandard stock.

Klarman is a value investor who always looks to get more value from a stock than he is paying for. And if such opportunities are non-existent, he'd rather sit in cash than do anything stupid.

If I haven't confused you enough, let me throw another legendary investor, Peter Lynch into the mix.

One of Peter Lynch's most famous statements is that far more money has been lost by investors in preparing for corrections, or anticipating corrections, than has been lost in the corrections themselves.

Well, the dean of growth stock investing seems to have made it clear that he doesn't like holding cash in anticipation of a correction.

Instead, he argues that investors should be 100% in stocks and view stocks as a long-term asset class, which keeps making new highs every few years.

Hmm...

I can keep throwing more famous names and their views at you. But I guess you got the message. There does not seem to be any consensus among the so-called market experts on what is the ideal stock market strategy when it comes to allocation to cash.

There are plenty of big names on either side of this debate and most of them have tasted success by following their respective strategies.

Some have made it big while always adjusting their sizeable cash position according to the market movements while others have been nearly 100% invested in stocks at all times and yet, have earned fabulous long-term returns.

Well, I will tell you about my view on this all-important topic.

You see, each one of us has only one long term goal when it comes to investing in stocks. We all are trying to outperform the benchmark index over the long term.

My way of outperforming the market is to avoid the most common mistakes that people make while investing and allow the rest to take care of itself.

Most people fail at outperformance or end up earning mediocre returns because they either get into stock market close to its highs or exit right after a fall.

You should be doing the opposite i.e. you should be increasing exposure to stocks after a fall and reduce exposure after a significant rise.

One of the ways to do this is to have a minimum 25% allocation each to stocks and cash at all times and move the remaining 50% based on the broader market valuation.

So, if the broader market is expensive, you can have as much as 75% in cash and only 25% in stocks and if the broader market is cheap, you can do the opposite i.e. have 25% in cash and 75% in stocks.

And when it is fairly valued, you can be 50:50.

This simple formula allows you to take more exposure to stocks after they have become cheap and reduce exposure after they have become expensive.

But due to their psychological make up, most investors fail to follow this simple step. Hence, following this simple mechanistic formula will allow them to do the right thing from a long-term perspective.

Another common mistake investors make is that they either end up in a highly speculative stock or end up paying too much for a good quality stock.

The way to avoid this mistake is to invest in fundamentally strong company with solid track record and have a maximum upper limit for valuations.

My thumb rule is no matter how good the stock, I don't like to pay more than 35-40 PE multiple for any stock. In fact, I like to keep it under 15-20 for most stocks.

This discipline allows me to have the risk-reward in my favour and puts me in a good position to earn superior returns over a 2-3-year period.

So, there it is, few simple rules to avoid some of the biggest mistake that investors make and then letting the process to take care of the long-term returns.

As highlighted, having a substantial allocation to cash is an integral part of this strategy. Hence, I am a supporter of having a sizeable cash allocation. High allocation to cash allows me to take advantage of Mr Market's follies rather than participate in it.

However, you don't necessarily have to follow this strategy. If your beat is to identify multibaggers on a consistent basis and you are not comfortable holding as much as 75% in cash the way I do, then please row that boat.

Luckily in investing, there is no one road to market beating performance.

However, all roads need discipline when it comes to business quality and valuations.

Happy investing.

Warm regards,


Rahul Shah
Editor and Research Analyst, Profit Hunter
Equitymaster Research Private Limited (formerly Equitymaster Agora Research Private Limited) (Research Analyst)