How much cash is too much?

CIO Global Blog

17 Sep 2019

It's understandable that investors view cash as a valuable tool for protecting against worst-case scenarios. After all, bear markets only cause harm to investors who are forced to sell out of their invested assets in order to pay their bills, locking in losses. But while a store of cash can be valuable, it also results in a drag on returns that, in the long run, could cause even more damage than the risk of being forced to sell at bear market prices.

Balancing protection and cash drag

There's no one-size-fits-all answer to this quandary. Investors should think about their cash allocation through the lens of our Liquidity. Longevity. Legacy.* framework—specifically, the Liquidity strategy, which is designed to meet cash flow needs without needing to sell risk assets during a downturn.

Our general guidance calls for a Liquidity strategy that's large enough to fund three to five years of cash flow needs. We also recommend that investors keep their Liquidity strategy fully funded during bull markets, and allow them to be depleted during bear markets. By following this methodology, a properly funded Liquidity strategy can leave their Longevity strategy untouched until the market has recovered from all of its bear market losses.

Three to five years is usually enough to "wait out" bear markets, but as we illustrate in our Bear Market Damage Index (BMDI) report, higher equity allocations tend to result in deeper and longer-lasting portfolio drawdowns, so investors with higher-risk Longevity strategies may need a larger Liquidity strategy to weather the full length of a bear market. 

On the other hand, setting aside too much capital in the Liquidity strategy could be costly. We expect very low returns, from the Liquidity strategy, especially after inflation. While returns can be enhanced by including cash alternatives and bond ladders, we advise investors to place strict limits on credit and liquidity risk—and eschew equity risk entirely—in this part of their portfolio.

"Average" is usually more than enough

To identify the right balance between protection and cash drag, we analyzed two methodologies for sizing the Liquidity strategy (Fig. 1). The "Longest" results simulate a Liquidity strategy sized for the risk profile's longest-ever modern bear market, while the "Average" results are based on setting aside enough Liquidity assets to cover the risk profile's average bear market window.

Most investors would be well-served by using the "Average" approach; it strikes a good balance between protection and cash drag, and gives investors a lot of patience to stay invested—and even take advantage of bear markets —in most scenarios.

We see little reason to set aside more Liquidity assets than the "Average" methodology. In fact, some investors may want to err on the side of a slightly smaller Liquidity strategy. After all, the "locked-in losses" results are overstated because they're based on our "super bear market" simulation, which is a worst-case scenario. In addition, even the "Average" methodology locks up a significant portion of the portfolio for more aggressive portfolios. For an investor with an Aggressive Longevity strategy, planning to spend about 4% per year, the "Average" Liquidity size would be 13% of the portfolio, versus about 24% under the "Longest" methodology.

Borrowing is part of the solution

Borrowing can be a useful tool for solving this dilemma. Although borrowing strategies do incur interest costs when they're tapped, they tend to be very cheap—or even free—to set up. When managed prudently, using the ability to borrow to replace some of the Liquidity strategy assets can help to limit locked-in losses while also reducing cash drag.

Borrowing during bear markets is not without risk, and it's important to have a plan for avoiding margin calls and other forced asset sales. Investors should plan ahead, building up borrowing capacity in good times and only tapping their securities-backed credit lines and other facilities as a plan B to selling the Longevity strategy assets at bear market prices. If managed carefully, the result will be superior to a Liquidity strategy that's composed solely of assets.

Figure 1 - Even without borrowing, preparing for an "average"bear market can provide a lot of protection

Results of a "super bear market" simulation, assuming a 4% p.a. spending rate, and a USD1mm portfolio comprised of Liquidity & Longevity strategies.

UBS, Morningstar Direct, R:PerformanceAnalytics, as of 16 September 2019

1"Bear market window time" is the number of months from a bull market peak to the next all-time high, based on monthly total return data since December 1945. Please see the Bear market guidebook ( for full details.

*Liquidity. Longevity. Legacy. disclaimer: Timeframes may vary. Strategies are subject to individual client goals, objectives, and suitability. This approach is not a promise or guarantee that wealth, or any financial results, can or will be achieved.


Jay Lee, CIO Strategist, UBS Financial Services Inc. (UBS FS)Karim Cherif, Strategist, UBS Switzerland AG