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For Warren Buffett the Cash Option Is Priceless

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CanadianValue
Sep 26, 2012
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I came across an article that is near and dear to my heart. The article discusses the option value of holding cash. Like most investors I vividly recall late 2008 and early 2009 when I had little cash available to invest in opportunities that were dramatically better than anything I had ever seen previously. During that time my admiration for Warren Buffett increased to another level because I knew that he was sitting on billions of dollars in cash and for him the stock market crash was an opportunity. After going through that experience I promised myself that going forward I would be more like Buffett, and less like me.

If holding cash in your portfolio for little return is driving you crazy, maybe it’s time to look at it the way Warren Buffett does.

Mr. Buffett, the world’s most successful (and richest) value investor, is sitting on almost $41-billion (U.S.) of cash at his Berkshire Hathaway holding company, the most in a year. Partly, that heap of greenbacks is a safety blanket. But it’s something more. As with most matters Buffett, the strategy is more complicated than it looks, Alice Schroeder says.

She should know. The former Wall Street analyst may know more about Mr. Buffett than anyone outside his family and inner circle: She spent more than 2,000 hours with him while writing The Snowball: Warren Buffett and the Business of Life.

Ms. Schroeder argues that to Mr. Buffett, cash is not just an asset class that is returning next to nothing. It is a call option that can be priced. When he thinks that option is cheap, relative to the ability of cash to buy assets, he is willing to put up with super-low interest rates, said Ms. Schroeder, who followed Mr. Buffett for years before she became his biographer.

“He thinks of cash differently than conventional investors,” Ms. Schroeder says. “This is one of the most important things I learned from him: the optionality of cash. He thinks of cash as a call option with no expiration date, an option on every asset class, with no strike price.”

It is a pretty fundamental insight. Because once an investor looks at cash as an option – in essence, the price of being able to scoop up a bargain when it becomes available – it is less tempting to be bothered by the fact that in the short term, it earns almost nothing.

Link to entire article: http://www.theglobeandmail.com/globe-investor/investment-ideas/streetwise/for-warren-buffett-the-cash-option-is-priceless/article4565468/

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