If Cash is King then what is Queen?
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Cash is really king when there is a crash.
We all know that the stock market cannot keep going up and there will come a time when we will see a crash. What is certain is the occurrence of a crash, what is not certain is when.
As Howard Marks always says 'We don't know where we are going but we sure do know where we are'. I think we all agree that we are not in a bear market for sure. So how do we prepare when one comes?
Following are the three things I believe we will need when the next crash happens.
Cash (King) :
'Predicting rain doesn't count, building arks does'. - Warren Buffett
This is no new information. Every investor is aware of the importance of cash in a bear market.
But knowing is not doing. Warren Buffett was able to put 5 Billion in Goldman Sachs in 2008 because he was able to build the cash reserve and wait for the opportunity. Most investors would not be maintaining enough cash reserve nor would they have the patience to wait. why is that we don't maintain enough cash reserve?
I think that is because most investors are not willing to sit idle with cash as they don't want to miss the ride.
They in turn deploy cash in average ideas just to be a part of the rally. Peer pressure and envy are causes too. Biggest Irony is that it takes a lot of effort to do nothing.
Though cash is important I don't believe it is the most important of the three. Then what is ? Lets look at the remaining two.
'Be Greedy when others are fearful and be fearful when others are greedy' - Warren Buffett.
It takes a lot of courage to be greedy when there is blood on the street and more so if some of it is your own. How is it that only few great investors have so much courage while most investors don't? Why does the majority sell in panic? while the minority is loading up?
Here is my thought, I don't think the investors who loaded up on stocks in 2008 were any less scared than those who were selling in panic. But they did muster the courage to go out and buy. My belief is that courage comes from knowledge and experience. These investors had ample experience and are great students of history, hence they acted rationally. They probably have read Adam Smith's book's multiple times.
If you read Adam Smith's SuperMoney you will know how 2008 was similar in some ways to 1970, but 2008 cannot be matched in magnitude with anything in history.
Small excerpt from SuperMoney:
Sunday night Treiber flew to Washington; the Fed’s Board of Governors met Monday at 9 A.M. By Monday
night, phone calls had gone out through the twelve Federal Reserve banks to every bank in the system—not just to big city banks, but to small-town banks all over the country. The Fed’s index finger was beginning to bleed from all the dialing. The message was the same: if anybody comes into your bank and wants a loan, give it to him.Then if you’re all loaned out, come to us and we’ll see that you have the money.
From that point on, events followed the script.The Penn Central went broke, but no one else did. Six billion dollars fell away from the commercial paper market, as buyers recoiled in horror. The companies that were going to sell the commercial paper and were unable to do so went to their banks and begged for money. The banks went to the Fed, the Fed loaned them the money, and the banks reloaned the money to the would-be insurers of IOU’s.
I think Lehman's bankruptcy in 2008 was in some ways similar to Penn central's bankruptcy of 1970.
And after Lehman's bankruptcy no firm was let to fail.
Though courage is important I don't believe it is the most important of the three.
When you have capital and courage to invest in a crash ,How much you invest and in which stocks is determined by your Conviction. So if Cash is King then Conviction is the Queen.
How does one gain conviction?
'Anytime I did not score on the following three things Accurate information, complete information & tremendous insight , I failed ' - Li Lu.
Conviction according to me comes from having the above three qualities mentioned by Li Lu.
My Experience in 2008: When the whole market was going crazy I knew it was a once in a life time opportunity to make huge money. Until 2008 I had experienced small corrections and had made money betting on them. So courage was not a problem. When 2008 happened I invested all my money and also borrowed from family and friends and invested. So getting cash was not a problem.
What was the problem then? I realized it only in 2010 when I booked losses in my 2008 investments.
The problem was 'I could not tell between a horse (good investment) and a donkey (bad investment)'. Lack of complete info. I bet on companies by looking at just few things without enough insights.
For example I lost money investing in a company by looking at just the management, my belief was good management meant good investment. This is like saying any animal that has a tail is a horse.
'We are generally better persuaded by the reasons we discover ourselves than by those given to us by others' - Blaise Pascal.
Following Great investors stock ideas is a good strategy to invest only if their stock ideas make sense to us.
Our research about the company should give us enough insights to invest with conviction.
As my favorite Indian guru investor Basant Maheshwari says 'Borrowed Conviction is more dangerous than borrowed Capital'.
Because we cannot borrow conviction with a borrowed idea we will not know what to do when the stock falls 20-30%. So conviction becomes very important.
In order to gain enough conviction we need to read everything there is to read about the company we are looking to invest in. In spite of all the research if we don't gain conviction we can give it a pass but we cannot gain superior results with superficial insights. So in that light I believe we need great conviction for great returns.
PS: In the game of Chess Queen is the most powerful piece. Though we lose the match when we lose the king(Cash) , I think we have already lost it when we lose the queen or in other words it is very hard to win without the queen(Conviction) even when the king(Cash) is alive.