Mutual Fund Red Flags: Just say "No" to Cash Reserves

When selecting a mutual fund there is an area that is commonly overlooked, and that is cash reserves.

Perhaps you have heard the saying, ‘Cash is king’, well that may be well and good but it’s not king when you are paying your mutual fund manager to sit hoard it. I can do just fine sitting on my own cash and I don’t think I need to pay someone two percent to sit on it for me.

With a historical return of 4% on cash why is my mutual fund manager sitting on so much of it. I am not talking about conservative income funds or the money markets; I am speaking of actively managed growth funds with ten percent of their holdings being cash. When you buy shares of mutual funds you are paying them to own stocks and you are not paying them to own cash instead.

There are basically two reasons for keeping so much cash on hand. The first reason is they are keeping the cash on hand just in case shareholders suddenly decide to sell of their shares of the fund. Should the end of the world be nigh, they have the cash there so they do not have to sell stocks when they are at the lowest prices ever.

In addition to that mutual fund managers keep some cash available is to take advantage of times when the market is oversold and there is a fire sale in the equities market. It the classic buy low sell high, timing the market. Obviously managers do this because they think they can time the market and actually get in at the low. No one else can do that but apparently fund managers can, or so they would have you believe. In theory this is great but in practice it has turned out the opposite.

Research shows that mutual fund cash reserves are at their low right when the market is at the high and at their highest levels when the market is at its lows. In other words, if there is anyone who knows how to time the market (probably not); mutual fund managers are not those guys.

Good luck and happy investing.