Should you optimize your cash in your portfolio?
By optimizing your cash, you try to minimize the cash you hold in your portfolio. The thought is that you want to earn as much as possible on your financial assets. But, is that the right thing to do?
I have been a Warren Buffett fan for a long time now (since the mid 80’s). One of the things I have seen in Buffett’s behavior (among others) is that he always has liquid assets available. Often, he holds a significant sum of cash. For example, right now he holds over $100B in liquid assets. The main stream thought process is that Buffett shouldn’t be holding as much cash, but should invest in and get better returns.
Over the years when either the economy, a sector or business goes through a downturn, Buffett “rides in one his white horse to save the day!” He offers companies financing with a high paying preferred stock in to get them in cash and out of trouble. For his efforts, he usually ends up with a sweet deal. So, when the chips are down and everyone is tight for cash, he bellies up to the bar with a boatload of “financial lubricants”.
So Buffett forgoes a short term bump up in returns for an expected much higher longer term return. That is one of the trademark attributes of the value investor. They are willing to forgo short term benefits for much longer term and bigger benefits. The value investor is patient and willing to wait. This is very different from conventional wisdom.
That said, you and I are not Buffett. We don’t have the venue or the horse to come to the rescue with mucho denarii. Nonetheless, we can learn something from his style.
If you optimize cash, when the market falls, you may have little cash to invest. So, you have to sell something to buy something. You are making a tradeoff. Will the tradeoff work? Maybe or maybe not.
While there is no easy way to test this, the value investor believes he can make more by having a good amount of cash ready to be put to work at the opportune moment. When the market falls, he doesn’t have to sell something to buy something. He just puts the cash to work by buying “inexpensive” securities that are on “sale”. That is when the value investor optimizes cash. He gets the best bang for his buck by buying securities on “sale”.
With the market at current levels, I try to keep my cash asset percentage in the mid-teens. I consider that a smart way to operate. No one knows when the market will tank next, but I think it is important to “keep your powder dry”.
The time to prepare for adversity is before adversity. Like a good boy scout – “Be prepared!”
