Affluent investors hold onto their cash piles during trying times
• Big names keep more than 40% of their assets liquid and take only calculated risks
In 2009 I took a piece of advice from a close friend that the market was too high and that I should go to cash and wait for a correction. Years later, I am still waiting and have missed record highs. How dumb is that? — Anon, January 2018.
The answer to that question seemed clearer last month than it did last week, when the markets finally took a turn for the worse. In hindsight, sitting in cash waiting for a correction wasn’t the smartest thing you could have done over the past few years, but that’s with the benefit of hindsight.
Sitting on the sidelines when it seems the right thing to do isn’t necessarily the poor decision it’s so often made out to be.
At the end of last year, Warren Buffett was reportedly sitting on a cash pile of more than $100bn. “I strongly believe that Buffett will sit on it for a prolonged period,” said Paul Koger of Foxy Trades. “He has firmly stated that the markets are priced at levels that are beyond reasonable valuations. And as his main strategy is to find $1 bills being sold for 50c, there aren’t many lying around these days,” said Koger.
Sitting in cash isn’t likely to be much of a problem at Berkshire Hathaway when Charlie Munger is often quoted as saying: “There are worse situations than drowning in cash and sitting, sitting, sitting … It takes character to sit with all that cash and do nothing. [But] I didn’t get to where I am by going after mediocre opportunities.”
Seth Klarman, author of the cult classic Margin of Safety, who also likes to buy stocks trading at a discount to their intrinsic value, likewise said that stocks held little appeal for the Baupost Group last year.
According to Business Insider, the group held as much as 40% of its assets in cash towards the end of the year. Prem Watsa, head of insurance conglomerate Fairfax Financial, was reportedly also holding 40% of his portfolio in cash (about $20bn) — “to deploy in case a hard market develops”.
Zor Capital MD Joe Fahmy, who has been trading for over 20 years, says he’s learnt not to hesitate to go to cash and sit things out. “If I’m wrong, I couldn’t care less because I’ve stopped worrying about ‘the fear of missing out’ and I’m more concerned with respecting risk and playing defence.”
Fahmy gave several reasons for his willingness to sit in cash:
❑ According to Harvard Business Review, the US economy is in a recession or depression over 60% of the time.
“I realise the stock market does not equal the economy, but they are related,” Fahmy said.
❑ The market is only attractive a few times a year. “Only when I feel an uptrend do I trade companies that are both fundamentally and technically strong.”
❑ During bear phases, four out of five stocks move in the general direction of the market. “In other words, I don’t care how good the company is because most stocks will get hit.”
“Ninety percent of what we’re taught about investing is flat-out wrong,” says Fahmy.
“That includes dollar-cost averaging, buy and hold, buy cheap stocks, and always be in the market.
“Some of the best traders who ever lived, including Jesse Livermore and Gerald Loeb, believed you should only be in the market when it’s in your favour, and the less the better.”
Gerald Loeb, in his book The Battle for Investment Survival, published in 1935, argued that the stock market is too fickle and too irrational to provide any security to the stock picker who buys on the company’s merits.
“Analysing companies a la Graham is as useless as giving medical check-ups to soldiers in the fox-holes,” Loeb said.
“Their vital signs telling you nothing about their chances for survival.”
Like Benjamin Graham and Graham’s protégé, Buffett, Loeb realised stocks were the only real chance a person had to increase wealth, but he didn’t think the way to do it was to sit back and be patient and wait for the true values to be reflected in prices. He believed in taking quick profits, buying and selling at key points, and taking advantage of trends.
In fact, the mainstream thinker in 1935 has become the perfect contrarian – every bit of advice he gives is the opposite of the prevailing view.
Stockbrokers, mutual fund companies and financial planners have been telling us to stay fully invested in stocks at all times, as otherwise we’re likely to lose out on some of the inevitable gains. Loeb, on the other hand, advised keeping a hefty percentage of our assets in cash and making only small bets on stocks.
Loeb deployed his capital in dribs and drabs, investing in a stock or two, getting out whenever the price dropped 10%, adding to his position on the rise … but always with his finger on the panic button.
That’s not to say cash isn’t a lousy investment. Not only does it dramatically lag the long-term return for stocks and bonds, it often doesn’t keep pace with inflation. Nevertheless, according to money manager BlackRock, many affluent investors keep more than 40% of their assets in cash, and fresh research makes the case that the emotional payoff may be worth the opportunity cost.
In a paper called How Your Bank Balance Buys Happiness: The Importance of ‘Cash on Hand’ to Life Satisfaction, researchers Peter Ruberton and Sonja Lyubomirsky of the University of California, Riverside, and Joe Gladstone at the University of Cambridge, compared the bank account balances for nearly 600 Brits against their reported levels of happiness. Their conclusion was that liquidity makes us feel better.
“While many individuals believe that increasing income or total wealth will improve their happiness, they may also benefit by building a financial buffer in their checking and savings accounts. We found this buffer to be associated with improved well-being regardless of how much a person earns, invests, or owes.”
Bridget Grimes, the founder of Wealth Choice, a San Diego financial planning firm, likewise has numerous clients whose cash positions are a multiple of the standard recommendation to keep three to six months of living costs liquid.
As Grimes has said: “If owning more cash makes you feel good and helps you sleep better at night, then that’s what you need to do.”
I REALISE THE STOCK MARKET DOES NOT EQUAL THE ECONOMY, BUT THEY ARE RELATED