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No. of Recommendations: 2
A portfolio consisting of stocks, bonds, and cash is about as basic as it gets, and most investors have their money concentrated in those three assets-classes, no matter whatever else they might be doing. Typically, stocks are owned because their relatively high risks are compensated for with relatively high returns. Typically, bonds are owned because their relatively low risks are compensated for by the lack of problems their ownership imposes. Typically, cash is owned because liquidity is needed (or thought to be desirable). So the typical allocation decision focuses on the question of “How much of each?”

How much cash, really, is needed? I’d argue that if one is running a small to mid-sized portfolio (say, $500,000 or so), then a 5% allocation to cash (or just $25,000), is probably enough to meet a typical household’s need for cash. A new car can be bought if it is needed, and most medical bills can be paid by check while waiting for the insurance reimbursements to be made. So that amount (or similar) becomes one’s petty cash /emergency/savings fund, and finding a credit-union that will offer a 3% APY isn’t hard to do. Yes, some administrative requirements have to be met. But the downside to not meeting those requirements is being forced to accept the truly miniscule interest-rates offered elsewhere.

3% isn’t a good rate of return. In fact, anything less than 8% isn’t a good rate of return, because anything less fails to preserve purchasing-power once taxes are paid and inflation is subtracted. But accepting a 3% rate on $25,000 (or 5% of AUM, whichever is higher) can be tolerated for the sake of maintaining a probably-adequate rate of liquidity. (YMMV)
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