Why Hold Cash?
“There’s a lot to be said when the world is going a little crazy around you, to at least put yourself in a position that if something really unpleasant happens, that it might be unpleasant but will be a non-event in terms of changing your life.”
– Charlie Munger, Wesco 2006 Annual Meeting
In our view, the best way to prepare for a “non-event” is to keep some dry powder on hand. With that in mind, here are a few points from a recent Long Leaf white paper on The Benefits of Periodic Cash in Equity Portfolios:
- In order to commit capital, we must believe we have a strong business run by honorable, capable management and priced at a deep discount relative to intrinsic worth.
- Compromising on these criteria, particularly the discount, introduces more risk of permanent loss than we are willing to take with our own capital.
- Likewise, when a stock no longer has what Ben Graham termed a “margin of safety” between its price and the company’s value, we sell the security, regardless of whether we have a qualified investment to replace it.
- Cash in our portfolio is, therefore, a by-product of adhering to our longstanding investment discipline and represents the opportunity to buy the next qualifying investment in the future.
- We hold cash only at points when we cannot find equities that meet our strict investment criteria.
- We have found that a low return on cash for limited periods is dwarfed by the return opportunity from the next deeply discounted qualifying investment that we buy.
- With cash on hand, we are positioned to be a liquidity provider and can immediately purchase stocks at what we believe to be advantageous points without being forced to sell holdings at unfavorable valuations.
- On average, funds that held 15% or more in cash outperformed their benchmark indices for the following one, five and 10 years. The outperformance relative to the benchmark indices increased the longer the investors’ time horizon.
- The returns suggest that low-returning cash not only offered the expected buffer in occasional down markets, but access to liquidity also enabled the purchase of new investments that served as the foundation for future successful compounding.
Nobody can predict when “something really unpleasant” will happen. But it is safe to assume that “the world is going a little crazy” after five years of money printing and zero percent interest rates. Consequently, the average cash balance in our equity portfolios is north of 40% today as we’ve continued to reduce investments where price has advanced more quickly than value.