“Bottom line: Cash only matters when it matters. And when it matters, it really, really matters.”
– Bruce Flatt, CEO of Brookfield Asset Management
When times are good, this quote sounds a bit quirky. But when the financial markets tumble, its practical wisdom is undeniable.
Cash Looks Foolish In a Bull Market
When the market is rising, it seems dumb to hold cash in your Investment portfolio. Whether in a money market fund or certificates of deposit, cash may earn next to nothing and seems to be a drag on return.
When comparing your returns to those of an index like the S&P 500, you will find that you’re trailing. An index like the S&P holds no cash, only stocks. The gas pedal is pushed to the floor all the time.
In a bull market, cash is disparaged. Commercials for financial advisors will urge you to find investments that “work as hard as you do.”
Cash doesn’t seem to do anything. It’s the lazy, good-for-nothing that lies on the couch all day and barely scrapes together anything for the rent.
Pity the Poor Financial Advisor
If you’re a financial advisor, clients will wonder why they pay you a management fee for an asset that offers so little. Yet cash may be the best choice when prices seem irrationally high.
We see this today in the fixed-income market, where interest rates are lower than they have ever been.
In a bull market, prices for even sketchy investments can rocket. “Why don’t you buy these?” your clients may ask. “Why bother with your skeptical analysis? Morons are making money while you just hold cash!”
Even worse, when the market is rising it seems smart to borrow so that you can buy even more. Policymakers may encourage this by driving down interest rates..
It’s easy to draw a line through recently rising prices and conclude that the next move has to be up.
But Cash Is Comfort & Opportunity In a Bear Market
But then something happens, and the market tumbles.
And cash looks different.
Now you see that what you have in a money market fund has a couple of things going for it:
It Provides Security
When the market drops sharply a few days in a row, people can’t help but draw a straight line between the points and calculate how soon they’ll run out of money.
But cash is different. It has a value you can count on. It’s a teddy bear when a thunderstorm rattles the windows and pounds on the roof.
It helps give you confidence that your investment portfolio is not going to zero.
It helps you stick to the long-term financial goals you have set.
It Can Have Great Option Value
If you are fully invested at the top of the market, you will have to sell something to take advantage of cheaper prices. You may get a bad price for what you have to sell.
If you hold cash you don’t have that issue.
Cash that had seemed asleep can wake up and show its value.
When others are panicked and selling, you can take advantage of the buying opportunities they may create.
It’s during turbulent times that you may be able to invest in the securities of very good businesses that rarely trade at favorable prices.
We spend a lot of time building a “wish-list” of investments. We look for good, well-managed companies that are available at reasonable prices. Market downturns can enable us to get those reasonable prices.
Barry Dunaway, CFA®
America First Investment Advisors, LLC
This post expresses the views of the author as of the date of publication. America First Investment Advisors has no obligation to update the information in it. Be aware that past performance is no indication of future performance, and that wherever there is the potential for profit there is also the possibility of loss.