Cash Reserves & Crash Preparedness
Holding some deliberate cash isn't sitting on the sidelines — it's the specific hedge against being forced to sell at the worst possible time.
"Dry powder" — cash held deliberately, not invested — is often framed as a drag on returns, and in a straight-line bull market, it is. Its actual purpose isn't return-chasing at all: it exists to make sure a market downturn never forces a sale of actual investments at a depressed price to cover a real, unavoidable expense.
This is a different, complementary idea from the All-Weather Portfolio's own bond/gold allocation covered in the previous lesson — that mix is designed to reduce the portfolio's overall swings; a cash reserve is designed to remove the need to sell anything at all during exactly the moment those swings are worst.
Rather than trying to time exactly when a crash has bottomed (a well-documented, extremely difficult thing to do reliably), a rebalancing-band approach sets a rule in advance: if any part of the portfolio's target allocation drifts far enough from its target weight (say, more than 5 percentage points), buy more of whatever fell, funded partly by the cash reserve. This deploys cash mechanically, into weakness, without requiring a prediction about where the bottom actually is.
A portfolio targets 70% stocks / 20% bonds / 10% cash. A sharp downturn drops stocks to 60% of the portfolio's value. Rather than guessing whether the decline is over, the investor mechanically rebalances back toward 70% stocks, using part of the cash reserve to buy more shares at the now-lower price. If the market keeps falling afterward, this doesn't feel great in the moment — but the buying happened at a materially better price than before the decline, without ever requiring a correct call on the exact bottom.
- The point of dry powder is explicitly not market-timing — it's insurance against being a forced seller during a downturn, which is a completely different goal from trying to predict one.
- A rebalancing-band rule, decided in advance while calm, removes the need to make a high-stakes, emotionally loaded decision in the middle of an actual crash.
- How much cash to hold is a direct function of near-term, unavoidable spending needs (see the Investing by Life Stage lesson) — someone years from needing any of the money needs far less dry powder than someone close to retirement.