Thursday, February 18, 2010

Cash is King - I must be on a tear with all these postings!

Cash is King

Cash as an investment is terrible – it only loses purchasing power over time. A loss one cannot even deduct from one’s taxes. (I recently read ‘A Time of Changes’ a Sci-Fi story by Robert Silverberg about a civilization where one is not to communicate in the first person, i.e. ‘I’ is a four letter word. The story got quite boring after the first 10 pages). Back to Cash.

So why bother with cash as a significant proportion of one’s portfolio? Cash is liquidity, it provides you options and in times of uncertainty it may even provide some capital protection. That is the reason why one should take profits when an investment becomes significantly overvalued like during ‘bubbles’. Even Warren Buffett states: ‘Nobody has made a loss by taken profits’. Another investor’s adage is: ‘Bulls and bears make money but pigs get slaughtered’. You see, “Greed is NOT good” in the world of investors contrary to what you may have heard from Michael Douglas. Value investor ‘par excellence’ John Templeton claimed that you should always sell so that there is still a bit left on the table for the next buyer.

You sell when profits are becoming excessive and buy when prices are good, thus you will have cash during the down times which inescapably follow the good times. “Seven years of prosperity followed by seven years of famine”, where did I hear that? Oh, yes that is a saying as old as ‘Methuselah’. Never let your cash level fall below 5% of your portfolio and during periods of overpriced assets (when you harvest your profits) you could build a cash position as high as 30 or 40%. Cash that is waiting to be invested in a well priced investment. You always hear Warren Buffett says things such as, “There are currently no well priced investments – I haven’t bought in years”. Or like last year: “This is this the best time to invest in a generation”. After building cash for years, Warren bought into GE and in Goldman Sachs and recently he bought an entire rail road (Burlington Northern) – his largest investment ever! Oh, there is another lesson in Warren’s philosophy: never sell in a panic.

One of the worst things you can do is selling into a major down turn. Things always (unless it is truly the end of the world) will get better. There are only 2 situations from which you cannot recover (one of them debatable). The company in which you invested goes broke (and even then there may be a chance to recover some of the money) or when you sell. When you sell there is no hope to recover. When Microsoft fell in 2008 from $32 to $12 dollars with no chance of bankruptcy I BOUGHT more. Now I have a tidy profit. Or when Bombardier crashed from $7 down to $3, I did nothing and we’re back over $5. All those analysts that were ‘whining’ in 2008 are now screaming ‘BUY’. We will talk more about ‘selling’ in later blogs – it is one of the toughest investment decisions to make!

So cash is an important part of everyone’s portfolio, you may need it for an emergency or for an investment opportunity of a lifetime. It helps you preserve capital in times of excessive overvaluation and lets you be ready to grab opportunities in an undervalued market. This has nothing to do with market timing, where you try to ‘pick market lows or highs’, but it often results in buying during bad times and selling during booms as a result of your cash management. Many people do not have the stomach to buy in bad times – that is one of the real reasons there are so few millionaires. Another blog topic.

In coming blogs I will discuss ‘fixed income’ – stay tuned.

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