“Cash is king,” and “cash is trash” are two investing maxims usually trotted out at just the wrong time. In the spring of 2009, when many asset classes were as cheap as anyone had witnessed in a generation, investors were proclaiming the former. Today they’re buying the latter expression and pairing it with, “don’t fight the fed.”
With cash paying literally nothing it’s easy to malign. But there’s one aspect of cash that most investors just don’t seem to get, especially during times like these: cash equals opportunity.
Pragmatic Capitalism recently ran this quote from Warren Buffett’s biographer discussing his perspective on the subject:
“He thinks of cash differently than conventional investors,” Ms. Schroeder says. “This is one of the most important things I learned from him: the optionality of cash. He thinks of cash as a call option with no expiration date, an option on every asset class, with no strike price.”… Suddenly, an investor’s asset allocation decisions are not simply between earning nothing in cash and earning something in bonds or stocks. The key question becomes: How much can the cash earn if I have it when I need it to buy other assets that are cheap, versus the upfront cost of holding it?”
I love that last question because it gets at the heart of the matter. Cash, to me, represents the potential for making great investments. Without the dry powder of cash Buffett would never have been able to hunt the investment elephants that made his career.
A friend recently sent me this note, written by a colleague of Bill Fleckenstein on the same topic:
We often went to 75-100% cash when it seemed like trouble ahead (late 1972, summer 1987, etc.). However, we had very little complaint from clients because in those days (before indexing and consultants), clients were well aware of downside risks PLUS “cash” paid very well when “sitting there” (honest interest rates). AND, we had a top 1% performance ranking over 5, 10, and 20 year periods so we were able to “get away with it.” As consultants came on the scene, with their arcane “models” and idiotic “advice” (many consultants were failed investors) they pushed the idea of benchmark measures of “success.” Then, over time, terrified so-called “Professional Investors” (fearful of losing AUM) started hugging their benchmarks and buying into the idea that “cash is trash.” That view of “cash” has always been pushed by brokers and others who derive no commission from “idle cash.” Therefore, much of the investing public is constantly pressured to “do something – do anything” to avoid holding “idle cash.” The tragic irony of the “cash is trash” propaganda in today’s markets is the fact that millions of formerly responsible investors are being deliberately pushed out on the risk curve.
This is another great point. The purpose of the Fed’s actions of the past few years is to push people out of cash and into riskier securities. But this is how bubbles are created and, ultimately, how fortunes are lost.
My advice: don’t believe the “cash is trash” hype.