Never forget the importance of cash

"Cash is King"

Losses may eventually force a business to close but in the short term, lack of cash is likely to be the critical factor.

You should hoard cash and you should plan your cash flow very carefully - daily if necessary.

Talk to your bank early and explain your plans.

Cash should be the number one priority.

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.

Understand why Cash is King

'Turnover is vanity, profit is sanity, but cash is reality."

The most common reason that businesses fail is not through lack of profit but through lack of cash.  Many failed businesses are highly profitable but run out of cash.


Profitability versus liquidity.

Whereas profitability is the return generated by a business, liquidity is the ability to pay expenses and debts as and when they fall due.  Liquidity is essential for the financial stability of a business.  A failure to manage liquidity may lead to a business being unable to pay its suppliers and debt holders, which may ultimately lead to bankruptcy.

Cash is like oxygen.

A useful analogy is that profit is like food, whereas cash is like oxygen.  The survival 'rule of threes' states that people can survive three weeks without food, three days without water, but only three minutes without oxygen.  Similarly, a business can survive without profit in the short term but cannot survive without cash.  If employees and suppliers aren't paid the business will not survive for long.

When the cash runs dry.

Although this sounds simple, many businesses don't place enough attention on their liquidity.

• Firstly, businesses aren't realistic when predicting their cash income and cash expenses.  Generally, they overestimate income and underestimate expenses. 
• Secondly, not enough businesses regularly forecast cash flow and foresee problems before they arise.  When they run out of cash, it's often too late.

Ideal goals.

Naturally, both a healthy cash flow and high profits is an ideal goal, but in practice it is not that easy.  

• The short-term goal of a business should be to manage cash flow, and 
• the medium- to long-term goal to manage profitability.

Deciding a suitable cash balance.

Businesses should discover their optimum balance of cash flow.  There is a balance between holding enough cash to meet all short-term demands and utilising cash in more profitable investments.  There is thus a trade-off between holding sufficient liquid assets and investing in more profitable assets.

Successful businesses manage cash flow in the short term and profit in the medium to long term.

Cash in a Clunker

Stock has moved up higher by 50% the last few months. Many who cashed out of the market during the downturn are paralysed. Some termed them as "paralysed investors".

However, cash is a clunker. Cash is earning nothing and its value is eroded by inflation. Also, the US dollar has fallen 20% in value relative to most other currencies. Moreover, when one is using one's cash savings, one is effectively dipping into or spending your capital.

There is always uncertainties in the market. Should you get in now? Why? You might be missing on more upsides. Should you get out now? Why? You might the miss a sell off, after all the market has risen 50% over the recent months. Perhaps, should you be selling out on some of your stocks? Why? To lock in some gains on stocks that have risen above "intrinsic" value.

Few months ago, shares were being sold at WHOLESALE PRICES. Now they are selling at RETAIL PRICES. Effectively, those "paralysed investors" who will be entering the market at this time are paying retail prices for their shares. How then can they re-employ some capitals into stocks? How can they get back into stocks?

Stay with high quality high dividend yield stocks which are likely to grow their dividend over time. Then start an investment program to buy into these on a systematic basis over time, for example, over the next 10 months. This is akin to cost averaging. As long as you stay with high quality high dividend yield stocks, even if the market were to have another sell down, these stocks should be quite resilient and the selldown may even be a good opportunity to buy at cheaper prices. More importantly, is by having an investment program in place, one can regain one's confidence to invest back into stocks; getting out of cash which is earning next to nothing at present.

The market is unpredictable. The less productive question to ask of oneself is "Is the market going down tomorrow?". The more productive and appropriate question is "Where will the market be in 3 or 5 years from today?"

Deflation: How to protect your portfolio

Deflation: How to protect your portfolio
Should you be protecting your portfolio against deflation or inflation, or hedging your bets? Emma Simon looks at the options

By Emma SimonLast Updated: 9:37PM GMT 27 Mar 2009

Investors face some tough choices as "zeroflation" leaves them caught between the Scylla and Charybdis of deflation in the short term followed by the risk of inflation in the medium to long term.

Should they be turning to the safe haven of government gilts as a hedge against deflation and economic depression?

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Or is there a bigger threat on the horizon – with inflation gathering pace again?

Investors could be forgiven for assuming that rising prices are the last thing they need to worry about given last week's figures.

The retail price index – one measure of inflation – has fallen to zero. In other words, prices remain unchanged compared to a year ago. This has prompted fears that recession may bring about a period of flat, or falling, prices.

But the Government's preferred measure of inflation – the Consumer Price Index – jumped unexpectedly to 3.2pc in February, showing that some prices are still rising ahead of Government targets.

Why is there a difference between these two figures? Put simply, only the Retail Price Index (RPI) takes into account monthly mortgage repayments. These have fallen sharply, thanks to an unprecedented series of interest rate cuts. CPI ignores this data, so there has not been any corresponding decline.

Most experts agree that, for the short term at least, we are in a period of zeroflation or even deflation. But many are warning investors to look to the long term instead.

David Kuo, of the financial website The Motley Fool, said: "It's inflation that investors should be guarding against." Like others, he is concerned that the "bail-out" measures adopted by governments across the world to kick-start the economy, could be storing up future inflationary pressures.

"For example the Government in the UK is now effectively printing money in a bid to ease the credit crisis. Mr Kuo said: "It's likely that once quantitative easing [the printing of money] permeates through the economy, we'll see the rate of inflation begin to rise again."

So what steps should investors be taking now to protect their portfolios?

Protecting against deflation
If you think that the British economy is heading into a protracted downturn akin to the "lost decade" Japan experienced in the Nineties then now is the time to play it safe.

In a period of prolonged depression and falling prices, equities will underperform, as company profits suffer. Instead, investors should look at government gilts and high-quality investment bonds, as these are likely to produce the best returns.

Juliet Schooling, the head of research at Chelsea Financial Services, said: "Gilts are considered the safest market instrument and can provide a safe haven in a deflationary environment. This is because the gilt will pay out a fixed rate of interest which will increase in value as prices fall."
Investors can buy gilts individually or through a fund. Ms Schooling recommends City Financial Strategic Gilt fund, currently yielding 3.33pc.

But Gavin Haynes, the managing director of Whitechurch Securities, said: "Deflationary concerns have pushed gilt prices up and yields have fallen to historically low levels. So unless you think we are entering a long-term deflationary environment, then they are starting to look expensive."

Although equities typically perform badly in deflationary conditions, Jason Collins, a multi manager from Ignis, said investors should not step out of the stock market completely.
"The emphasis should be on selecting 'winning companies'. Look at very defensive sectors that are not sensitive to the economic cycle".

He added that investors may also want to target "the strongest companies in more cyclical sectors that will take market share from the weaker players that fail".

He added: "Deflation is particularly bad for those with big debts and physical assets – so property values are likely to fall and the real value of your mortgage debt will increase."

Adrian Lowcock, senior investment adviser at Bestinvest, said: "In the current climate there are a number of steps investors can take which will benefit them if prices fall, but also make good sense for the long term."

Given that debt increases in real terms in periods of deflation, Mr Lowcock said investors should spare funds to reduce the size of their mortgage.

He pointed out that investors should not overlook cash savings. "With interest rates so low, cash savings can look unattractive. But remember if we enter a period of deflation then in real terms your money is growing by 3pc a year."

http://www.telegraph.co.uk/finance/personalfinance/investing/5063248/Deflation-How-to-protect-your-portfolio.html