Coping with Market Volatility: Use Cash to Help Manage Your Mindset

Holding cash alternatives in a portfolio can be the financial equivalent of taking deep breaths to relax. It can enhance your ability to make thoughtful investment decisions instead of impulsive ones. Having a cash position coupled with a disciplined investing strategy can change your perspective on market volatility. Knowing that you're positioned to take advantage of a downturn by picking up bargains may increase your ability to be patient.

That doesn't mean you should convert your entire portfolio into cash. A period of extreme market volatility can make it even more difficult than usual to pick the right time to make any large-scale move. Watching the market move up after you've abandoned it can be almost as painful as watching it go down. And are you sure you'll be able to pick the right time to move back into the market? Finally, an all-cash portfolio may not keep up with inflation over time; if you have long-term goals, you need to consider the impact of a major change on your ability to achieve them.

Unless you're retired and using the income from your portfolio for living expenses, having a cash cushion in your portfolio isn't necessarily the same thing as having a financial cushion to protect you against emergencies such as medical problems or job loss. An appropriate asset allocation that takes into account your time horizon and risk tolerance should provide you with enough resources on hand to prevent having to sell stocks to meet ordinary expenses or, if you've used leverage, a margin call.