Holding a lot of cash can seem like a boring choice for an investor. With interest rates where they are today, investors holding cash are paid almost nothing.
As such, it can be tempting to find other assets to try and boost returns. This approach can yield a better performance. After all, all you'd need to do is buy a bond with a rate of more than 1% to earn a higher rate than cash.
However, while investors who follow this route might make a higher return, it removes one of the most desirable qualities of cash: flexibility.
Buffett on the flexibility of cash
The one advantage cash has over any other asset is flexibility. It will always be there when you need it, and there won't be any limitations on withdrawals or the possibility of it losing value due to market conditions.
This isn't the case even with U.S. Treasuries, which are generally considered to be the world's safe-haven asset. According to reports, even the Treasury market came close to collapse earlier this year when markets around the world plunged. Investors who depended on this market may have been shocked to find they could not sell their investments.
Cash investors wouldn't have had the same problem. They would have been able to withdraw cash to take advantage of the market declines whenever they wanted. That's the tradeoff cash owners make. They have to make do with lower returns, but in return, cash is far more flexible.
This flexibility is worth the tradeoff, according to Warren Buffett (Trades, Portfolio). Speaking at the 2011 Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) annual meeting, Buffett declared that cash and short-term Treasuries are an "unattractive parking place, but it's a parking place where we know we'll get our car back when we want it."
Buffett's right-hand man at Berkshire, Charlie Munger (Trades, Portfolio), then added his two cents to the debate. In typical Munger style, he said:
"Well, of course, I've watched a lot of people struggle who thought it was their duty in life to get an extra 10 basis points on the short-term money. I think it's really stupid to try and maximize returns on short-term money if you're in an opportunist game the way we are, where we want to suddenly deploy money."
Buffett went on to provide an example for the audience:
"We bought one pipeline where the seller was worried about going bankrupt the following week. And there's a Hart-Scott-Rodino clearance required through the FTC, and they needed the money right away, and we — I wrote a letter, as I remember, to the FTC, and I said that we will do whatever you tell us to do later on. You can look at this all you want. We'll give you all the data you want. And if you tell us, you know, to unwind the deal, whatever you tell us, we will do. But these guys need the money, and so we closed it earlier. And our ability to come up with cash when people need it and when the rest of the world is petrified for some reason, has enabled several deals to get done."
Investors often overlook the power of cash as an asset class, but they shouldn't. Cash provides optionality, and that should not be ignored.
It might cost money in real terms, but there are lots of benefits to holding cash. Buffett was able to make deals quickly with Berkshire's large cash balance.
The average investor might not want to follow the same playbook, but cash savings give other protections as well. They provide a cushion against losing your job or having to meet an unexpected bill.
If you don't have this cushion in place, you might be forced to sell an investment at just the wrong time. That's why cash is king. It always has been, and it always will be.
Disclosure: The author owns shares in Berkshire Hathaway.
Read more here:
- Warren Buffett on Investing in Tech and Sector Experience
- Now More Than Ever, Investors Need to Know When to Sell
- Seth Klarman's 3-Stage Approach to Valuation
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