One takeaway from 2008 – 2009 is that sometimes diversification does not work as planned. Most investment asset classes declined in the credit crisis.  Cash is the conspicuous exception.

As noted in last Friday’s post, reserving for liquidity is even more important than usual (given my perception) of the elevated prospects for a market convulsion, as we make our way back to the old normal.  There’s a lot to be said for cash as an alternative to bonds.  If interest rates or inflation spikes and bond prices plunge, and if cash is available to scoop up the bargains, losses on long positions can be mitigated.

Holding cash means accepting a negative rate of return on an inflation adjusted basis.  Long-term, this is a losing strategy.  As a tactical allocation, it means not being greedy.  And if you need liquidity, it’s just common sense.

Finally, if the US dollar falls in a currency crisis, the price of imports will rise.  Perhaps the best way to hedge against the currency risk of cash, is an expanded international allocation denominated in foreign currency.  But if the “correction” is global, then the US dollar will be as good as other currencies and might prove to be a safe haven.  If this seems like a circular argument, that shows how interconnected things have become.