An Interesting Article - for sharing

Should You Be Mostly Cash Like Mohamed El-Erian?

Apr. 6, 2015 5:49 AM ET | by Cullen Roche

Mohamed El-Erian, the former PIMCO chief revealed an interesting personal asset allocation in a recent interview - he's holding mostly cash. Here's the specific excerpt:

Q. Where is your money? Stocks? Treasuries? Bonds?

A. It is mostly concentrated in cash. That's not great, given that it gets eaten up by inflation. But I think most asset prices have been pushed by central banks to very elevated levels.

Q. So we're nearing a bubble?

A. Go back to central banks. Central banks look at growth, at employment, at wages. They are too low. They don't have the instruments they need, but they feel obliged to do something. So they artificially lift asset prices by maintaining zero interest rates and by using their balance sheet to buy assets.

Why? Because they hope that they will trigger what's called the wealth effect. That you will open your 401k, see it has gone up in price, and you'll spend. And that companies will see their shares are going up and they will be more willing to invest. But there is a massive gap right now between asset prices and fundamentals.

This is something I run into quite a bit these days. Investors are convinced that stocks are overvalued and excessively risky and they also believe that bond yields can only go up and will therefore result in principal loss. This leaves the investor paralyzed and unable to feel comfortable doing anything except sitting in cash. And the years go by and they find themselves simply losing out to purchasing power erosion.

The simple reality of the financial markets is that someone somewhere always ends up holding cash. Someone always feels like they're falling behind. So don't feel so bad about that part. But a 100% cash position is entirely irrational most of the time because it leaves you totally unprotected against inflation. For most investors, even the most conservative, we should be protecting against two risks:

1. The risk of purchasing power loss.
2. The risk of permanent loss.

Let's make an extreme point here for emphasis. Stocks might be risky, but that risk can be largely offset inside of a diversified portfolio. We all want the high return of stocks, but we don't want the rollercoaster ride that comes with it. The reason we try to own uncorrelated asset classes is specifically so we can hedge the risk of high volatility assets like stocks.

This article is not written by me but this is something I believe most investors experience hence some food for thought.