Wednesday, 15 August 2012

Cash is a drag on your portfolio BUT it has a hidden embedded option value.

Cash is a drag on your portfolio, says the conventional wisdom.  Its returns are low and often negative after inflation and taxes.

But cash has a hidden embedded option value.  When markets crash, cash is king.  All of a sudden assets that were being traded at 5 and 10 times the money spent to build them can be had for a fraction of their replacement cost.

Highly leveraged competitors go bankrupt, leaving the field free for the cash-rich company.

Banks won't lend money except to people who don't need it  - such as the companies with AAA credit ratings and people with piles of money in the bank.

In times like these the marketplace is dominated by forced sellers who must turn assets into cash regardless of price.  This is when the investor who has protected his portfolio by being cash-rich is rewarded in spades:  people will literally be beating a path to his door to all but give away what they have in return for just a little bit of that scarce commodity called cash.

Additional note:
Buffett always has cash in Berkshire Hathaway.  In 2008 Global Financial Crisis, many companies approached Buffett as he has plenty of cash which they sought to have badly.

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