The idiocy of cash.

**disneysteve** · 04-21-2011, 04:43 PM

I think you need to have, and stick to, an asset allocation that includes cash, fixed-income (bonds) and equities. If you want to throw in real estate, commodities or other asset classes, that's fine, too. Then you should rebalance periodically to get back in line with your desired allocation.

How much should be in cash? That depends on your age, your goals and your risk tolerance.

Yes, we have money in cash and cash equivalents. No, it isn't because of current market conditions or any predictions about near term performance. It is just part of our allocation. Always has been. Always will be. Though the percentage has changed over the years and will continue to change as we get older and closer to retirement.

**tan fish** · 04-21-2011, 06:32 PM

For me its somewhat of a matter of both definition and intention. When I think of "cash" I literally think of cash, and not things like CDs or fixed income vehicles. I do have a fair amount of cash, but its in my savings accounts. Its there because I don't want to risk it in investing, its liquid, and I can get it within 24 hours or so. I do not consider any of this cash part of my portfolio, and I have no expectations that it will grow beyond the measly interest rate it accumulates. Its basically for near-term and medium-term purchases and peace of mind - i.e. a big security cushion that I will know is always there. I wouldn't call that idiotic.

My portfolio is strictly for what I consider "investments" which does not mean cash (again, this is my own way of approaching it). My portfolio in turn consists of both my retirement investments, and non-retirement investments, which is pretty much all individual stocks, mutual funds, or ETFs (though I'm sure my mutual funds hold some cash-vehicles and bonds, etc.). Contrary to my cash in my savings account, my expectation and management of my portfolio is all about growth.

Having said all these things, my own personal philosophy is that beyond whatever cash you have as a comfortable EF and for near and mid-term purchases, you should invest it in something that will grow. Guess I am aggressive in that sense. Just looking at the past few years since the crash, its obviously been a huge comeback in equities, and there is still room for more growth compared to the highs we were at previously.

**JBinKC** · 04-23-2011, 03:04 AM

I agree holding the USD in the form of cash or bonds is absolutely the worst investment to make in these times. It pays a great deal less interest than other currencies with much better fundamentals behind them and well behind current inflation. However, a word of caution the monetary fundamentals are starting to shift to a deflationary environment again as well as a slight shift in government policy towards shrinking its size. Velocity has been falling like a rock since the first of the year and QE2 ends in June. I think a switch to bonds in strong foreign currencies like the NOK and AUD will effectively counter the negative effects from this liquidity drain until markets sell off again which I am expecting and until Bernanke decides to go on the next money printing binge.

**Scanner** · 04-23-2011, 07:18 AM

When you ask these kinds of questions, I think it's always helpful to go back to fundamentals -

A. Are you an investor or trader? (I assume an investor, so your need for cash won't be as much)

B. What do you want to own? There are essentially 2 asset classes - equities and debts that you can own.

Cash, in a way, is a debt instrument. YOu are loaning the bank your money, and they are paying you interest to loan it out to someone else, correct? Right now, I think my business LOC, I am paying 6% on. I have about 12K on it. So, you gave the bank 12K and they paid you 0.25% interest and they turn around and loan it out to me for 6% - operating costs of the bank (the teller, overhead, advertising) = Their Profit.

Does this sound like a good deal to you?

Who is the good deal for?

I have none of my investment portfolio in cash. Crap. . .I'd own Treasuries and loan the government money before I'd loan banks money.

**rj.phila** · 04-23-2011, 07:36 AM

Jbinkkc-I actually don't think it's idiocy, not sure if you read my post. If you agree it is, that's fine, but I was hoping to actually dispel some of this myth, or at least gain a better informed perspective.

I heard it said once that Warren buffet was sitting on too much cash because he couldn't find enough investments he felt strongly about. This is in essence my conundrum.

It's not that I need cash. It's that I obviously earn in cash, and the spread RIGHT NOW btw my 1.5 pct savings and a 2.8 pct bond or treasury is not enough to entice me out of cash now. I see big opportunities in RE by EOY, if not now, so im not looking at fixed income now.

I guess what I'm wondering is this-when cash is not optimal, but merely the most suitable option at the moment, how small does the spread in interest have to get before YOU all steer away from risk?

**disneysteve** · 04-23-2011, 07:48 AM

Originally posted by rj.phila View Post

how small does the spread in interest have to get before YOU all steer away from risk?

Tthat just isn't how I do things. Cash is for emergency funds and funds we anticipate needing in the next 3-5 years (travel, cars, home repairs, etc.). Everything else is invested elsewhere. I would not have 40-45% of our portfolio in cash because that wouldn't fit our desired asset allocation.

I guess I'm not following your statement that you've reached your comfort level in your exposure to other asset classes. My comfort level is based on a percentage of assets, not a specific dollar amount, so we won't ever reach a point where I wouldn't continue to invest.

**rj.phila** · 04-23-2011, 08:24 AM

Steve-you've put your finger EXACTLY on the heart of the issue for me. The percentage of asset class, to me, actually depends on an assessment of the risk/return ratio of the vehicle.

Put another way, at what return levels to you reconsider you AA? So, let's say you have decided that 40pct corporate bonds is one AA. In what conditions do you rethink this? Hownlow would bond returns and volatility have to go for you to rethink? Bottom line, it's hard for me to divorce the idea of a general investment plan from the actual returns and risks. It seems rational to me, and yet, I get the impression people think it's a bad idea. Does it have to be?

**Scanner** · 04-23-2011, 10:03 AM

I see nothing wrong with, even as an investor, of being in cash for awhile if nothing looks attractive to invest in.

That is, don't feel like you have to put it in "something" (equities) just because the pundits tell you to.

That being said, why does NOTHING ELSE look attractive to you? I mean, I am not sure about how much cash we are talking about but why not some dividend paying stocks or a basket of utility stocks?

Last I checked, we were all using utilities.

**Scanner** · 04-23-2011, 10:12 AM

Then again. . .

If you sit on cash for any extended period of time, then in essence, you are thinking like Gambler, a trader - trying to time and move and flow and ebb with the markets.

Remember, if you own "cash", then you are deciding to own "the dollar" and in essence, making a bet on the dollar.

Do you think the dollar is a good investment for the long haul?

You see. . .an investor may or may not. . .a trader like Gambler just uses the dollar for his currency. It means nothing to him other than a way to define his trades, although one could make the arguement since he is not an investor, 100% of his portfolio is cash and he's 100% "in the dollar."

**disneysteve** · 04-23-2011, 11:53 AM

Originally posted by Scanner View Post

I see nothing wrong with, even as an investor, of being in cash for awhile if nothing looks attractive to invest in.

That is, don't feel like you have to put it in "something" (equities) just because the pundits tell you to.

But doesn't that go against the whole point of asset allocation and periodic rebalancing?

If you decide to hold 70% stocks, 20% bonds and 10% cash, that's what you should hold. If you let that drift up to 40% cash then you might only be at 50% stocks and 10% bonds. At what point do you decide to reenter the stock market? Waiting until the sector looks "attractive" is market timing, isn't it? Trying to predict the low point.

I'm not saying this is right or wrong. It is just a different investing philosophy. Personally, I prefer to stay invested. I don't know when the market will be up or when it will be down so I keep my money in there all the time, adding to it systematically over time.

I have had times where my cash accounts unintentionally drifted upwards. When I realized that, I redeployed some of that excess into my other investments to even things out but the build up in cash was more the result of decreased spending or additional income that wasn't factored into the automatic investment plan.

**JBinKC** · 04-24-2011, 03:23 AM

Originally posted by rj.phila View Post

Jbinkkc-I actually don't think it's idiocy, not sure if you read my post. If you agree it is, that's fine, but I was hoping to actually dispel some of this myth, or at least gain a better informed perspective.

I heard it said once that Warren buffet was sitting on too much cash because he couldn't find enough investments he felt strongly about. This is in essence my conundrum.

It's not that I need cash. It's that I obviously earn in cash, and the spread RIGHT NOW btw my 1.5 pct savings and a 2.8 pct bond or treasury is not enough to entice me out of cash now. I see big opportunities in RE by EOY, if not now, so im not looking at fixed income now.

I guess what I'm wondering is this-when cash is not optimal, but merely the most suitable option at the moment, how small does the spread in interest have to get before YOU all steer away from risk?

I don't think you read my post or understood it at all. I indicated given the fundamentals of our fed policy changing which has shown reduced velocity of money which BTW has a 100% correlation to an impeding market correction and the fact money printing will end in June which has propped up the stock market because investment banks has really no other alternative sources to invest this excess cash as borrowing needs of low risk loan clientelle is nearly nil makes the market vulnerable to a sell off.

I would say at this time it is wise right now to raise cash in the form of bonds but I think it would be a better idea to keep "cash" in foreign currencies because interest rates have risen markedly in many countries from rising commodity prices and are currently quite a bit higher in those currencies and a bond holder would benefit more in the form of potential capital gains from dropping rates. I agree with you the switch to US treasuries isn't worth the time of day since there is little spread between long and short term rates.

However, I think once it is evident Bernanke starts QE3 it is time to invest in the market again then it would be time to reduce cash holdings.

I think holding USDs over the long term is a a very risky move because our debt to GDP ratio being above 90% which has been shown to be the point where it begins to become difficult to maintain government services and entitlement programs so rates will stay artificially low because the debt service would be easier to manage. However, when those conditions exist inflation will set in and those rates will be higher than your rates of return on cash. In addition, I think the value of the USD would be vulnerable to drop because our rates will likely be lower than competing currencies.

As for real estate I would attempt to look for data that tracks long term selling inventory in your area once it shows evidence of dropping again I agree it would be a good time to buy.

**rj.phila** · 04-24-2011, 11:48 AM

Originally posted by Scanner View Post

I see nothing wrong with, even as an investor, of being in cash for awhile if nothing looks attractive to invest in.

That is, don't feel like you have to put it in "something" (equities) just because the pundits tell you to.

That being said, why does NOTHING ELSE look attractive to you? I mean, I am not sure about how much cash we are talking about but why not some dividend paying stocks or a basket of utility stocks?

Last I checked, we were all using utilities.

This is a VERY helpful response for me, scanner. Thanks. Utility stocks, especially if they were indexed, would be a good alternative for me.

Disneysteve-while I agree with and share your reticence to endorse "market timing", we're not talking about jumping in and out of the stock market for me, per se.

Jbinkkc-thanks ffor the response. I read your response- Maybe I didn't make it clear enough from my post at first that the subtext was trying to dispel the idea of cash as poor move.

While I agree that holding cash equates to a long term bet on the USD, and the potential problems with it, if you are a us citizen you are, in some for or another, making a bet on the stability of the USD, merely by using it and earning it, no?

Lastly, inflation. While I happen to be reading "the age of deleveraging" at the moment, thus slightly biased,I'm not fully sold on the pundit idea of massive permanent inflation over the next decade. There are, frankly, plausible arguments on both sides.

Thanks for all the thoughts, guys. It's a nice environment to market test some of my ideas across multiple "belief systems", if you will!

**jpg7n16** · 04-24-2011, 03:56 PM

Originally posted by rj.phila View Post

This is a VERY helpful response for me, scanner. Thanks. Utility stocks, especially if they were indexed, would be a good alternative for me.

Disneysteve-while I agree with and share your reticence to endorse "market timing", we're not talking about jumping in and out of the stock market for me, per se.

The reason you're getting different advice is they're coming from 2 different investing strategies.

1) DS's strategy is based on the entire portfolio allocation, and is based on the efficient market hypothesis. This is a passive top-down strategy, where you first start with the overall allocation - then select investments to fit it. For the vast majority of investors, this is the way to go. Even WB mentioned that the average investor should extensively diversify and not trade ('this would lead to broad index type funds') {as mentioned in this video: Warren Buffett MBA Talk }

2) Scanner's strategy is more of an actively managed bottom-up type strategy. Where you select investments based on their individual criteria and merits, and don't worry too much about what asset allocation you wind up having. If it's a good investment, it should be added to the portfolio, if not, it shouldn't. This is a much more specialized strategy, and should only really be used by people who understand what they're doing - and I don't mean they read a book on stocks one time. They should be able to calculate intrinsic value, and understand the true nature of the market. (Buffett uses this strategy because he's obv very experienced and knowledgable, and that's why his comments reflect that idea - the average investor shouldn't invest this way)

So for a passive strategy, you should create an asset allocation - of which cash may be 5-25% depending on your age and risk tolerance. Too much in cash is an error, because your allocation is messed up.

But for an active strategy, you should only use your cash to invest if a profitable opportunity comes along. Too much cash really isn't an issue, because the allocation doesn't matter- and there are no profitable investment opportunities available.

**disneysteve** · 04-24-2011, 04:22 PM

JPG - Great post. Thanks for clarifying that.

Truth be told, I am not a firm adherent to the asset allocation investing model, but it is the basis of the advice I typically give.

The idiocy of cash.