STREET DOGS

There are some classy arguments for sitting in cash. Warren Buffett, for example, thinks of cash not just as an “asset class that is returning next to nothing”, but rather as “a call option that can be priced relative to the ability of cash to buy assets”. Something he put to good use during the most recent financial crisis.

David Merkel at the Aleph blog has a far more pedestrian reason for holding cash that “especially applies to the little guy who’s bought popular shares hoping they’ll do well”. It goes something like this: “Invariably, when a significant panic hits the market … the value of their portfolio falls a lot, but they don’t sell or worry immediately, because they have a solid job and a buffer of a few months’ expenses set aside. Then a second shock hits. In the midst of the panic they suddenly face, say, the loss of their job (or severe trouble in their business), disability with no insurance, divorce, a health problem not covered by insurance or any one of the other nasty things that can take us by surprise. Guess what?

“Even though they planned ahead, the plan did not consider true disaster, where two things fail at the same time; when, suddenly, the buffer becomes inadequate and in order to live our investor is forced to sell his or her stocks at a time when they are truly undervalued.

“If this seems unlikely,” says Merkel, “keep in mind the correlation between unemployment and credit panics with bear markets. Other contingencies may not be as correlated, but the odds of them happening when the stock market is down are still positive.”

The thing is, the time to plan for a flat tyre is before you have one. The same is true for financial disasters. The planning is best done in the good times.