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The Science of Hitting
The Science of Hitting
Articles (489) 

The Behavioral 'Cost' of Holding Cash

Some thoughts on holding large cash balances in a bull market

March 29, 2018 | About:

A few weeks ago, the 2017 year-end letter to clients from Semper Augustus Investments Group made its rounds among the investment community. There was a lot of interesting commentary in the letter. This discussion on cash caught my attention (edited for length; starts on page 20 of the letter):

“Clients should always be curious as to plans for cash. We do not like having lots of cash lying around, but we also preach patience. We are fans of buying low, which requires low prices. Sometimes we’ll wait for more attractive entry points, despite the existence of portfolio positions at undervalued prices…

In our almost 20 years running Semper Augustus, cash has never helped us. Cash balances held during the 2000-2002 bear market hurt results because while the S&P 500 fell 50% and the NASDAQ Composite more than 80%, our stocks made money and outperformed cash yields by a wide margin over the period. We would have been better off fully invested. We built some cash during 2004… our stocks, and the market, were up a bunch that year, and cash balances were a drain on results. We were fully invested by late 2007, and despite losing far less than the markets during the 2008 bear market, didn’t have cash as a helping offset… Most recently, the cash raised for process in the last few years, as discussed, has been an anchor on returns.

We are getting to be old dogs. Wisdom ideally comes with age. Although they say you can’t teach an old dog new tricks, we hope we are learning. We may make a resolution that once we get today’s liquid reserves invested that we will swear off cash for good. We think cash on hand today will be deployed at even better prices and yields than available at present. The trick is getting it to work soon enough and at low enough prices to have warranted its existence in the first place.”

This hits close to home. I’ve held a fairly significant percentage of my investment portfolio in cash and short-term treasuries in recent years (it was approximately 20% at year-end 2017). Any way you cut it, this has been a major headwind to my portfolio returns over the past three or four years.

But this article is not really about the drag on investment results. I want discuss the behavioral aspect of holding cash for a long time – and the secondary impact it has on decision-making.

This is something that has become more apparent to me as some opportunities appeared in the past few weeks. I’ve made some investments, including a new position in Comcast (NASDAQ:CMCSA) and incremental purchases of Wells Fargo (NYSE:WFC). I have a high level of conviction in both names and believe they will be sound long-term investments from current levels. As a result, the cash that took years to stockpile has been moving out at a fairly rapid pace.

That should not be an issue. Holding cash was never the objective. It was an output based on an inability to find securities offering adequate forward rates of return. That changed when the opportunity set improved. I decided to invest in Comcast and Wells Fargo on that basis.

So here’s the practical question I had to answer: with a relatively large percentage of my portfolio in cash, and a handful of stocks priced for double-digit annualized returns (by my math), how much of the dry powder should I put to work? I think you can look at it from a few different angles.

You could make the argument that I should be pretty aggressive if they clear my hurdle rates, especially if you think we’re at a point where forward rates of return for equity markets will be in the mid-single digits (Vanguard expects 3% to 5% annualized returns for U.S. equities over the next 10 years). The same applies to cash as a long-term investment. Again, relative to the alternative, I think Comcast and Wells Fargo are much better options.

Relative to the other stocks in my portfolio, I would say that comparison is more difficult - but I still think Comcast and Wells Fargo come out ahead (that is why I am buying them).

I am not confident enough to say each of these securities will be winners if you apply some “cost” – a required excess return – to account for holding cash over the past few years. Let me say that another way: because I’m considering the legacy “cost” of holding cash (missed equity gains over the past three to four years), it's almost as if I feel I should hold out until Mr. Market offers some serious outsized returns (15%-plus per year). Barely clearing my hurdle doesn’t seem good enough.

Here’s the point: I think there’s some baggage associated with deploying cash, especially when it has been held on the sidelines for years during a bull market. As time goes by, you start telling yourself that you need a home run as compensation for your patience. You look at most ideas and go, “I could’ve bought that for less two or three years ago when I had a pile of cash – so why would I put 5% of my portfolio into it now?” Suddenly, you’re slow to take the bat off your shoulder when you see securities that clear your return hurdle.

Getting to fully invested without a large drawdown in the markets almost feels like admitting defeat. If you’ve been in cash since the start of 2013, the “more attractive entry points” you’ve been waiting for is 40% to 45% below current levels (using the S&P 500). We’ll see how long it takes to retest those levels – if we ever see them again.


I’ll close with something I’ve noticed in the past couple of quarters: what the team at Semper Augustus Investments Group said about cash in their letter is something I’ve seen elsewhere. The conclusion from these investors is that, over an investment lifetime, holding cash has been a drag on returns. If you look at a long-term chart for the S&P 500, it’s not hard to see why. Jumping in and out of a "stock" that has historically delievered returns of 9% to 10% annualized is a difficult game to play.

It sounds like Semper Augustus is still holding out hope: “We think cash on hand today will be deployed at even better prices and yields than available at present.” I tend to agree; I think that may be true for my current cash on hand (or else I wouldn’t be holding it). But I also thought that was true in 2013 and 2014. With hindsight, we can see I was almost certainly wrong.

After 20 years in the business, it sounds like they are considering a change in their approach (“We may make a resolution that once we get today’s liquid reserves invested that we will swear off cash for good”). I’m not there yet – but I’m more open to that possibility than I used to be.

Disclosure: Long CMCSA and WFC.

About the author:

The Science of Hitting
I'm a value investor with a long-term focus. As it relates to portfolio construction, my goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach to investing is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with a handful of equities accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

Rating: 5.0/5 (15 votes)



Vipartner premium member - 8 months ago

Provides nice affirmation as I have also been building a postion in both CMCSA and WFC since late February 2018. Both have good metrics and look undervalued. I have also been nibbling at KR; competitive landscape, solid metrics also looks undervalued.

The Science of Hitting
The Science of Hitting - 8 months ago    Report SPAM

Keeping an eye on KR. Haven't invested to this point, but find the industry developments quite fascinating. And think we'll do well on our CMCSA and WFC over the long run. Thanks for the comment Vipartner!

Stephenbaker - 8 months ago    Report SPAM

Science, the issue and perspective of holding cash can vary widely between professional money managers and indvidual investors. Professionals have to answer to their investors for all decisions, including allocations to cash. OTOH, individual investors may prefer to hold cash for many reasons (sleeping well at night being at the top of the list). Professionals have to report results on a relatively frequent basis and attract/not lose business. Individuals can take a much longer term approach, sacrificing current results for (hopefully) future, long term payoffs. Individuals also have personal tax consequences to consider, whereas professional money managers are usually eager to achieve outsized results regardless of the tax consequences. Bottom line, Buffett/Munger's 20-stocks-in-a- lifetime approach still has its merits for individual investors and allows us to have a life and businesses outside investments.

Ilovesummer - 8 months ago    Report SPAM

Buffett holds cash .

If you don't hold cash you are essentially dollar cost averaging.

Jtdaniel premium member - 8 months ago

Hi Science,

Thanks for a great read and much food for thought. Interesting that management of a fund named for a speculative tulip bulb from 17th Century Holland would fret about holding some cash, nine years deep into a bull market. That just has to say something about human nature.

Judging only from the excerpt you quoted above, I would think their most significant mistake was being fully invested in late 2007, in the early stage of a brutal bear market. Surely such experienced and sophisticated investors would go out of their way to avoid a repeat performance. That said, I have little doubt that Berkshire, their largest holding, will outperform cash over time. Best, dj

Snowballbuilder - 8 months ago    Report SPAM

Bottom line, Buffett/Munger's 20-stocks-in-a- lifetime approach still has its merits for individual investors and allows us to have a life and businesses outside investments.

Fully agree

You can be always full invested in index or you can be selective, focused and patient

On average been always fully invested in index will do better result.

But If you have the right temperament , stomach and mind you can ignore the average been better than the average and walk your way as a focused long term investor.

Few bets, big bets, infrequent bets.

Best snow

Dirt2624 premium member - 8 months ago

The reality of permanenet capital is really what matters - if capital can leave because you have a high cash allocation dedicated to a future opportunity set then you have to play the fully invested game. It is a stupid game and should never be played if it can be avoided.

The Science of Hitting
The Science of Hitting - 8 months ago    Report SPAM

Stephenbaker - I think that's a fair point. Thanks for the comment!

The Science of Hitting
The Science of Hitting - 8 months ago    Report SPAM

Ilovesummer - Dollar cost averaging over the long-term is probably a pretty decent strategy, don't you think? Maybe not optimal, but far better than some alternatives...

The Science of Hitting
The Science of Hitting - 8 months ago    Report SPAM

Jtdaniel - I almost added a line at the end of this article: "Don't think I've overlooked the somewhat peculiar timing of this article, nine years into a bull market!" :)

As you noted, food for thought. Like many things in investing, not black or white. As always, thanks for the thoughtful comment!

The Science of Hitting
The Science of Hitting - 8 months ago    Report SPAM

Snow - Can't disagree with that! Thanks for the comment.

Mtochs premium member - 8 months ago

Between BRK.A and B Semper Augustus' current poisition is 45.7% Berkshire. Berkshire's current largest position is cash. So Semper Augustus' largest position is cash by proxy.

Hpxtreme - 8 months ago    Report SPAM

Agreed with a few of the above commenters, still good to hold cash if you're not confident.

Bruce Bohannon
Bruce Bohannon premium member - 8 months ago

BRK is sitting on over 115 Billion in cash. Their patience level is off my chart. So, is their track record.

Stevezhangsan premium member - 8 months ago

Thank you, a great article!

Stevezhangsan premium member - 8 months ago

agree with you

The Science of Hitting
The Science of Hitting - 8 months ago    Report SPAM

Some fair points. Thanks for the comments everybody!

The Science of Hitting
The Science of Hitting - 8 months ago    Report SPAM

Fair point, reasonable people can disagree on this topic. Thanks for the comments!!!

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