Sunday, May 19, 2013

The Markets Are Global: How Cash Can Take Many Forms

You've heard that hedge funds, pension funds, mutual funds, or your next door neighbor are holding X percentage of their holdings in cash. Usually this number is extremely low and only rises after prices fall and people become afraid (see 2008). Then, over time, the fear slowly leaves the market and investors become more and more convinced that it is safe to tread back out into the ocean.

If you think about holding cash in your portfolio you have more options than just holding X amount of dollars down at your local bank in your local currency. We live in a global financial world today and cash can take the form of numerous currencies, many of which we will talk about today. 

What follows is a simple thought experiment that I do on a daily basis to figure out where capital will perform best within the world of none yielding cash alternatives. This thought process can be extrapolated out to any asset class you believe is attractive. For example:

If I thought stocks were undervalued and under-loved, I would spend my time deciding on the best sectors within the stock market, then the best stocks within those sectors. For example, people that recommend buying stocks today may say that American technology stocks are an attractive sector of the total market. Within that group there may be a few specific stocks they expect to be the best performers, such as Google or Facebook.

If I thought real estate was an undervalued and under-loved asset class, I would spend my time deciding on the sector within the real estate market, then the best location to purchase that type of asset. For example, people that recommend buying real estate today may say that retail property is an attractive sector. Within that group they may believe that markets such as San Francisco or Phoenix will be the best performers for the retail market.

At some point, after capital and sentiment begin to move away from stocks, bonds, and real estate (higher yielding assets), we will be having in depth conversations on the best opportunities in that area.

A normal financial adviser will recommend that you have a portfolio that consists of X amount of stocks, X amount of real estate, and X amount of bonds to give you a total of 100%. The type of thought experiment we are moving through today cannot be found in a world where your adviser only makes money if you purchase from the three above.

Today's discussion is not a recommendation that someone should own (or not own) any of the asset classes discussed. It is just another way I can try to explain how my mind works when I view the financial markets, which will hopefully open your mind to the complex layers that are involved in any portfolio decision. 

Up Next: How Capital Flows Impact Currency Movement

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