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For Warren Buffett the Cash Option Is Priceless

September 26, 2012 | About:

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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Rating: 4.1/5 (19 votes)


Swnyc2 - 5 years ago    Report SPAM
Canadian Value,

I think it makes sense to keep enough cash on hand so that one is not forced to sell a security at an inopportune time. For instance, if there were a disaster and Berkshire needed the cash to pay out on insurance claims, Buffett wouldn't want to be forced to sell a stock at a disadvantageous price just to raise cash.

It also makes sense to keep cash when one cannot find a stock to purchase at an attractive valuation.

However, the idea of keeping cash on hand just in case a good value comes along doesn't make a lot of sense to me. In that case, one could sell some other stock that was not priced as favorably to raise cash. Being fully invested wouldn't prevent one from taking advantage of an opportunity unless the whole market tanked. In which case, keeping cash on hand would be trying to time the market -- something many (included Warren Buffett) would say is unwise to do.

Roke6362 - 5 years ago    Report SPAM
Maybe your philosophies are different. Your sentences:

"It also makes sense to keep cash when one cannot find a stock to purchase at an attractive valuation."


"However, the idea of keeping cash on hand just in case a good value comes along doesn't make a lot of sense to me."

They seem to contradict themselves.

As I understand the article, WEB is willing to hold cash indefinitely as a way of decreasing the risk of losing money, rather than making a larger return.

If your belief is to maximize return and less about risk of capital loss, then I see your point. I went through the 2007-2009 period not unscathed.

It taught me a lot. After that period, I am much more concerned about risk of loss than about maximizing return.

Currently, I am about 30% cash. Time will tell.
Sm2200 - 5 years ago    Report SPAM
If you hesitate holding cash, then as the bull market ages (we're in the 4th year now) consider buying uutility stocks.

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