Is cash king or is cash costly? – The Royal Gazette | Bermuda News, Business, Sports, Events, & Community

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Is cash king or is cash costly?

“The one thing I will tell you is the worst investment you can have is cash. Everybody is talking about cash being king and all that sort of thing. Cash is going to become worth less over time. But good businesses are going to become worth more over time. And you don't want to pay too much for them so you have to have some discipline about what you pay. But the thing to do is find a good business and stick with it. We always keep enough cash around so I feel very comfortable and don't worry about sleeping at night. But it's not because I like cash as an investment. Cash is a bad investment over time. But you always want to have enough so that nobody else can determine your future essentially.” — Warren Buffett

Since May we have seen strong flows into money market funds amounting to $94 billion. Most of this may be due to the surge of selling from bond funds. Some $65 billion has flown out of fixed income mutual funds according to fund tracker Lipper. The bulk of this, about 70%, has come from municipal bond funds that suffered greatly by Detroit's bankruptcy filing and rising interest rates. Lately, chatter on Syria, the debt ceiling and the Federal Reserve's decision not to taper have added to higher levels of near-term uncertainty and have caused many to raise cash in portfolios. Given these macro concerns it probably seems reasonable to see investors move more to the sidelines. This trade is, of course, predicated in investing in what is deemed a riskless asset: cash. There are good and bad aspects in regards to allocating significant levels of cash to your investment portfolio. I'll touch on these briefly.

The case for cash

Cash is often a neglected asset class. In many aspects it doesn't get the credit it deserves. The often quipped phrase “Cash is King” refers to its near certainty around its value and expected return. In environments with high levels of uncertainty and disparate outcomes, the perceived value of cash increases tremendously. When other alternatives seem risky or valuations appear stretched, cash offers a haven.

The bull case for cash is that at some point and on purely valuation terms, cash actually is the most attractive asset class. When all other asset classes offer little to no investment potential, cash should be your default. This, I would argue, is a rare instance as it is unlikely that ALL potential asset classes at any given point offer no viable return option.

The other positive aspect of cash is its optionality. Holders of cash actually own an option to purchase more volatile assets once they become cheap. It offers one the ability to take advantage of tail risks like a financial crisis as its value remains constant and liquid, offering the holder the firepower to execute in buying depressed assets.

Safety at a price

Safety and comfort do, however, come at a price. Holding extensive levels of cash can lead to a very strong probability that you as an investor will not meet your long-term investment goals. In fact, cash may actually be detracting from your ability to secure a stronger retirement and increase wealth over time.

The major scourge of cash holders is inflation. Holding cash is pretty much an assured way to lose purchasing power in the long run. In major developed economies cash has not kept up with the consumer price index over time, so its value has diminished in real-terms. According to Blackrock, in a paper published in May of this year titled ‘Rethink the Cost of Cash', from 1926 to 2012 cash is the only asset class that has been shown to have a negative real after-tax return. In country such as Bermuda where inflation is persistently running near 3% the eroding effect on cash can be devastating.

The bottom line is that we believe cash should always be a part of one's investment portfolio. For those more risk adverse its stability and near certainty should lend itself to a higher allocation. For those more comfortable with volatility they should hold a smaller share but still some. Some proponents of market timing expose an all-in cash or all invested mantra. Unfortunately, I would never personally prescribe to this as I have yet to meet a rich market timer. I believe more fully in the saying that it is not timing the market that counts but time IN the market that counts. The best option is to continue to stick to a diversified portfolio that balances one's desire for capital preservation with one's need for income and growth.

Disclaimer: This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Anchor Investment Management Ltd. to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. Readers should consult their financial advisers prior to any investment decision.

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Published September 30, 2013 at 9:00 am (Updated September 29, 2013 at 3:36 pm)

Is cash king or is cash costly?

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