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Why cash will never be trash

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By John Beveridge - 
Cash trash Ray Dalio Warren Buffett Bridgewater



“Don’t think why, just buy’’ seems to be the latest share market mantra and it is being embraced with gusto.

As the market charges ever higher, the other saying that has been popular is “cash is trash” – an alternative to the “all in, buy alert’’ which is meant to be saved for a very rare rainy day but now seems to pop up all the time.

Perhaps the biggest proponent of the “cash is trash’’ mantra is billionaire hedge fund manager and Bridgewater Associates boss Ray Dalio, who has consistently urged investors to avoid cash since the start of the year.

Dalio versus Buffett on cash

That call proved to be controversial after shares crunched hard in March due to the COVID-19 pandemic but since then he has been basically proved right as stocks have recovered all of that lost ground.

Dalio’s argument is that with interest rates at tiny lows and central banks supplying plenty of new currency, cash is the worst asset to be in during a reflationary period.

While he admits cash is less volatile than other investments, he thinks those holding cash will miss out once the global economy starts to recover.

He also points to cash not keeping pace with inflation, saying: “There is a costly negative return to it in relation to goods and services and other financial assets that amounts to about a couple of percent a year, which adds up.”

If you want to see a marked contrast to Dalio’s approach, it is hard to go past the world’s best investor, Warren Buffett, whose investment vehicle Berkshire Hathaway has a massive cash pile that was valued at an amazing US$346 billion (A$470 billion) at the end of the June quarter.

While Berkshire’s share portfolio is worth a lot more than the cash pile, Buffett has always argued that it is prudent given his value investment style to keep large amounts of cash ready for big acquisitions when the need arises.

Buffet keeps using the cash pile

He took action on that idea recently when he bought US$5 billion (A$6.8 billion) of shares in some of the big US pharmaceutical companies: AbbVie, Bristol Myers Squibb, Merck and Pfizer.

Buffett has been watching the pharmaceutical sector for more than 20 years and at his annual meeting in 1999 said that: “If we could buy a group of leading pharmaceutical companies at a below-market multiple, I think we’d do it in a second.”

Buffett has also been using the cash pile to buy back his own shares, increasing the earnings per share as he continues to scan the market for large investments at great prices.

Bridgewater more volatile

Compared to Buffett, Dalio’s investment performance this year has been far more volatile, with Bridgewater’s stock heavy flagship fund suffering a 20% fall in the first quarter before bouncing back as markets recovered.

In some ways the contrast between Dalio and Buffett is one of investment styles but the big lesson to learn from their performances is that cash is never entirely trash.

While the returns on cash may be tiny in nominal terms and negative after inflation is taken into account, there is a big danger in re-interepreting the cash is trash mantra into an instruction to have all of your investments in shares and commodities and none in cash or cash alternatives.

Professional investors all keep some cash

There is not a super fund or professionally managed fund in Australia that would have a zero allocation to cash and/or bonds and for the very good reason that cash always gives you options to grab investment opportunities when they come up.

What may be arguable is the percentage of a portfolio allocated to cash rather than investing in stocks, commodities, property and other assets.

Some investors keep only a few percent of their assets in cash, some others keep up to 20% or more.

More cash means less volatility and lower potential returns

As a general rule, the more conservative and risk averse the investor is, the greater the allocation to cash and bonds, even with the knowledge that cash returns may drag down the overall portfolio return over time.

The greater certainty provided by cash is usually reflected in lower volatility, which often helps the more conservative investor to sleep well at night, which is an important consideration.

Pandemic showed the usefulness of cash

The recent COVID-19 pandemic shutdowns were a graphic reminder of the need to keep some cash on hand at a personal level, as well as a portfolio component in super and personal investments.

For those who followed the rule of keeping three months of living expenses stashed away in an emergency account, the shutdowns provided a perfect illustration of the wisdom of that idea.

In investment terms, Dalio has a point that the returns on cash may be trash at certain times of the economic cycle compared to other investments.

However, cash itself is never trash and there are other times in the investment cycle when it is the best asset of all.

After all, how can you ever buy a bargain investment without having some cash tucked away ready to use?