Reading a number of blogs it becomes clear that many Stockopedia clients currently have relatively large cash holdings due to the belief that markets are currently overvalued and therefore a correction is due. Being in cash has the double advantage of avoiding the initial decline in value of your portfolio (albeit probably temporary) and being in a position to pick up quality stocks at more realistic prices. I would guess that for many this cash is held inside ISAs and SIPPs and therefore investors are reluctant to lose the benefit of the tax wrapper and wish to leave the cash where it is ready to invest when the time comes.

For some this holding period has been and could continue to be a fairly lengthy period. Whilst the decision has been consciously taken to forgo the equity returns on the cash at the current time, these cash holdings, which earn little or no interest, are being eroded by inflation. Assuming a 20% cash holding and inflation at 2.5% this represents a bite of 0.5% from the overall real returns of your portfolio.

So what are the options?

1 Continue to hold as cash. The benefit of being able to employ funds quickly following a correction outweighs any opportunity cost. 

2 The old mantra of don't try and time the market and stay fully invested. This is particularly relevant if you are a buy and hold investor with a long term horizon. A portfolio of safe shares earning a 3% dividend will yield you 20% over a 6 year period which can be ploughed into bargains during the recovery.

3 Short dated corporate and government bonds. If you are prepared to wait until maturity to get your cash your capital values will be unaffected by interest rate increases. For instance I have a holding in £PF21 which I picked up last year at a yield to maturity of around 8%. I considered 3 years to be a reasonable period to wait. Ideally a spread of maturities and instruments across say 2, 3 and 4 years would work best in my view given a steady flow of cash as they mature. Problem is that the yields on most good quality short dated bonds are paltry and in some cases the spreads eat up much of the return

4 Bond fund index trackers and ETFs e.g. Vanguard…

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