With the stock market ascending to record heights and bonds having very little upside given the low interest rate environment, it is very logical to argue for increasing the percentage of cash in your portfolio.  While money market interest rates aren’t even close to 1%, inflation is fairly low at the time, and the optionality of cash can be a powerful advantage when a bear market hits.  To me, optionality is the key word because the reason you want to hold cash is because you want to be able to buy stocks when they get cheaper.  For most long-only mutual funds or traditional asset allocation plans, cash is the only way to achieve that optionality.  The problem with holding cash is that your purchasing power continuously declines due to inflation and their are significant opportunity costs.  For example, for those that got invested in cash at the end of 2012 after a nice year in the markets, have missed the 26.7% gain in the S&P 500 in 2013.

This is where stock-picking and strategy come into play.  At T&T Capital Management (TTCM), we hand-select each and every security after performing extensive research and analysis.  This allows to identify the areas of the market that we find attractive and then we focus on the individual securities that offer the best risk-adjusted returns.  We aren’t afraid to take concentrated positions when we feel we have a sufficient margin of safety.  In addition, we use strategies such as selling cash-secured puts to create that same optionality that can be attained by using cash.  For example, let’s say that we believe Citigroup (C) is worth $70 and the stock is trading at $50 per share.  That is a reasonable margin of safety but perhaps we are wary about the market and want to make the investment even safer.  We might sell a $50 put for $7 or $700 per contract.  Two things can happen assuming you hold the option till expiration.  If the stock expires above $50, you would make $700 per contract on the maximum risk of $4,300 or 16.2%.  If the stock expires below $50, you will own 100 shares of Citigroup at $43 per share, which is 16.2% lower than the price in this example.  Since a bear market is defined by a 20% drop in stocks, you are basically buying Citigroup after the stock endures its own bear market of sorts, which is what you’d want to do anyways.  The reason I prefer this strategy is that you aren’t giving up that opportunity cost by just sitting in cash the whole time, as a 16.2% return if the stock is flat or slightly up is certainly nothing to sneeze at.  This is the difference between dynamic money management and cookie-cutter money management.  Below is the article in the WSJ that outlines some of the logic on holding on to cash.