One of the primary reasons you buy shares of a mutual fund is to put your money to work for you, making more money. You probably expect the fund's manager to invest your dollars wisely in a diversified portfolio of securities that matches your investment objectives. But not all of the money you invest in the mutual fund goes to buy securities. Some of it is held in cash, and that's not necessarily a bad thing.
Fees and Expenses
Mutual funds don't run themselves. Even index funds, which attempt to match the composition of a particular stock index and don't require a lot of buying and selling, have fund managers. Mutual funds incur transaction fees, commission payments and other expenses in the course of doing business, and all the people who work for the mutual fund must be paid. Keeping some of the fund's assets in cash allows the mutual fund to pay transaction fees, its employees and operating expenses.
Mutual funds maintain some cash holdings to cover predictable share redemption requests. One of the big benefits of owning mutual fund shares is their ready liquidity. Mutual fund companies must stand ready to redeem their shares during regular business hours on any business day. Since each fund typically has a history of how many shares are purchased and redeemed on average, the fund's manager should have a pretty good idea of how much cash needs to be on hand to meet the demand for share redemption. Having ready cash reduces the need to sell securities to meet redemption needs.
Mutual fund managers are paid well to manage the fund's portfolio. They are always on the lookout for a great deal. Deals in the stock market can come and go rapidly. A fund manager who has the ability to act on a deal immediately has an advantage. That's where cash holdings come in. Having a portion of the fund's resources in cash gives the fund manager the ability to make the deal when it becomes available.
Cash might not be such a great investment when inflation is running rampant, but when the stock market is in free fall, cash starts to look pretty good. Mutual fund managers might convert a portion of the fund's assets into cash holdings or cash equivalents -- such as short-term U.S. government bonds -- as a protective measure during bear markets in hopes of buying bargains once the market turns positive again.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.