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Robert Stephens, CFA
Robert Stephens, CFA
Articles (428) 

Warren Buffett on the Importance of Holding Cash

Avoiding being fully invested may be a good idea in this bull market

February 09, 2021 | About:

It can be tempting to invest all of your assets in stocks during a bull market. The recent returns of the S&P 500, which has risen 75% since its low in March 2020, may convince some investors to avoid cash in favor of stocks.

This urge may be heightened by the low returns currently available on cash savings. An accommodative monetary policy may mean that they even struggle to outperform inflation over the next few years.

However, in my view, cash could be an underrated asset to hold at the moment. A likely future bear market means a cash pile could represent an efficient use of capital in the long run.

Holding cash in today's bull market

Having a large cash pile at the moment could mean missing out on further stock market growth in the short run. Investor sentiment is strong, while the economy is forecast to grow 3.1% in the current year. This may catalyze stock valuations so that being fully invested in equity markets is a more profitable play compared to holding cash for a limited amount of time.

However, the current bull market is very unlikely to last forever. The S&P 500's track record shows that every bull market has ultimately been followed by a bear market. Predicting when this will occur is impossible, due to the range of factors that can prompt a stock market crash. Therefore, having cash available to invest at all times may allow an investor to use short-term market movements, such as a correction, to their advantage in terms of buying undervalued stocks.

Rich stock valuations

Many stock valuations are currently at relatively high levels. This could indicate that they have not taken into account potential threats to the economy, such as further disruption caused by antitrust (in the case of big tech) or the Coronavirus. Highly-valued companies may not provide scope for large capital gains due to their lack of a margin of safety. Therefore, holding cash until valuations are more attractive may represent an efficient use of capital.

Cash savings also provide peace of mind, as well as financial security in case of unexpected costs that may be incurred at any time. Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) chairman Warren Buffett (Trades, Portfolio) has previously justified his large cash holdings for this reason. As he once said:

"We never want to count on the kindness of strangers in order to meet tomorrow's obligations. When forced to choose, I will not trade even a night's sleep for the chance of extra profits".

A balanced portfolio

The low return prospects of cash means that it cannot be relied on to offer a high return over a sustained period of time. For instance, the U.S. Federal Funds Rate is expected to be just 0.25% by the end of 2022. Therefore, holding cash instead of purchasing stocks may only be a temporary strategy for many investors. This point has previously been highlighted by Buffett:

"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".

However, in my view, having a balanced portfolio that contains stocks and cash could represent a logical apportionment of capital at the moment. It enables an investor to take advantage of undervalued stocks that may still be available, but also avoid rich valuations that have become increasingly commonplace in the current bull market.

Disclosure: The author has no position in any stocks mentioned.

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