Investors and fund managers for the most part avoid holding cash. The most successful investor, Warren Buffett, has long held cash when he cannot find opportunities to deploy capital. As of the third quarter 2006 Mr. Buffett sat a top a huge pile of cash, over $40 billion. To emulate Mr. Buffett, one should hold cash until he/she finds opportunities which will earn returns sufficiently above the risk free rates offered by treasury bills with limited downside.
Holding cash when opportunities do not exist is a corner stone of a successful investment philosophy. One must be able to wait patiently for bargain priced equities that meet your investment criteria. First, one does not want to focus on a desired rate of return. Instead must first eliminate the risk of permanent impairment of capital. After the risk of a capital loss is removed, then one must decide if a potential investment provides superior returns versus the present 5.25% investment in U.S. Treasury bills.
Warren Buffett offers business school students a terrific idea: one is only allowed one punch card, with twenty investment punches. Therefore, an investor will be more selective to invest only in his/her top investment choices. Only twenty wonderful investment ideas are needed in an investor’s lifetime.
“Don’t think you can avoid making a choice; inertia is also a decision.” — Margin of Safety by Seth Klarman
Mr. Klarman’s book Margin of Safety is presently out of print but can be obtained with an intra-library loan. Mr. Klarman runs an investment partnership that also employs Warren Buffett’s strategy of holding cash when bargains do not exist.
Holding cash is a default position. An investor can not be completely inactive. One must actively pursue bargain stocks and/or bonds, then compare these opportunities to the risk free rate of return on cash. If an opportunity offers a sufficient margin of safety and is priced to give an investor an adequate rate of return, then one needs to punch one of their twenty available punches on their card.
One must not be afraid to hold cash in the face of low quality opportunities. Hence, loading up when bargains exist and searching constantly when they are not to be found. Further your understanding of quality businesses that are in your circle of competence when no bargain priced opportunities are available. When opportunities abound, you will be ready to take advantage of them while one earns the adequate 5.25% risk free rate of return on treasury bills.
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Peter Lindmark is the managing partner of Lindmark Capital Fund (www.lindmarkcapital.com) a value based investment fund. He can be contacted via email at plindmark@lindmarkcapital.com.
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Holding cash requires that you have the courage to "pull the trigger" when things are very bleak, like the low point of the day on August 16th 2007. Did you have your list ready, and then -did you have the nerve to push the buy button -when the Dow was down over 300 points? Great if you did!
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