What is cash drag?

Cash drag is the reduction in a portfolio's return caused by holding part of it in cash instead of investing it. Cash is useful — for emergencies, for planned purchases, for peace of mind — but over long periods it earns less than stocks or bonds. The larger the cash position and the longer it lasts, the more return it costs.

The formula

A portfolio's return is the weighted average of its invested part and its cash:

R_p = (1 - w_c) \, R_{\text{inv}} + w_c \, R_{\text{cash}}

where $w_c$ is the share held in cash, $R_{\text{inv}}$ the return of the invested part and $R_{\text{cash}}$ the interest earned on the cash. The cash drag is the difference to a fully invested portfolio:

\text{Cash drag} = R_{\text{inv}} - R_p = w_c \, (R_{\text{inv}} - R_{\text{cash}})

A simple illustration

A portfolio holds 15% in cash earning 2% a year, while its invested part returns 9%:

\text{Cash drag} = 0.15 \times (9\% - 2\%) = 1.05\%

The portfolio returns 7.95% instead of 9%. Over 20 years, €50,000 grows to about €231,000 instead of about €280,000.

When cash helps

Cash drag is the cost of an insurance, and in some periods the insurance pays out:

In falling markets, cash does not fall. In a year in which the invested part loses 20%, the same 15% cash position turns a 20% loss into a loss of about 16.7%.
As a reserve, cash avoids having to sell investments at a bad moment to cover an unexpected expense.
When interest rates are high, the gap between cash and investments narrows, and so does the drag.

How to read it

Deliberate cash — an emergency reserve, money needed within a few years — is part of a plan, and its drag is an accepted cost.
Accidental cash — dividends and savings that pile up uninvested, or money waiting for a "better moment" — is where the drag is usually largest and least noticed.
Waiting for a dip has historically cost more than it gained on average, because markets rise in more years than they fall.

Measuring it in practice

Comparing a portfolio's time-weighted return with the return of its invested holdings alone shows how much the cash cost over a period. A cash share that has crept up over the years, well beyond any planned reserve, is a sign that savings are not being put to work.

A worked example

Worked through on a sample portfolio. The figures below are that portfolio’s, not yours.

What if I had not held cash?

You asked: "What if I had not held cash?"

Summary using your portfolio data:

Your portfolio value today would be 90.989,80 €.
Cash today is 5.510,23 € (6,06% of the portfolio).
Removing cash means reallocating that amount across your existing holdings proportionally to their current weights (the simulation below assumes no trading costs, no currency changes, and no new buys/sells).

Table — hypothetical effect of removing cash and distributing it pro rata across holdings

Asset	Value now (€)
Apple Inc.	16.749,00 €
iShares Core MSCI World UCITS ETF	15.054,60 €
Microsoft Corp.	10.571,25 €
MasterCard Inc.	9.702,00 €
Deutsche Lufthansa AG	7.648,00 €

Notes:

The table shows the current values of your top five holdings; the same proportional redistribution would add 5.510,23 € across all holdings according to their current weights.
Assumptions: cash removed today; redistributed pro rata to existing holdings by current weight; no buying/selling costs; prices and exchange rates unchanged; no further cash flows.

If you want, I can run the full redistribution now and show the new per-holding values, new weights and the resulting unrealized gains.

See these numbers for your own portfolio

Floreo works out every figure on this page from your own holdings — returns, risk, allocation, currencies — and the assistant explains them the way this page does. Import from your broker, or try it on the sample portfolio first.

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