Liquidity brings opportunities.
Do not rush to invest in stocks as soon as you have additional cash available for investing. Be patient and wait for good investment opportunities.
Holding cash or cash equivalents is not just for safety; it can help you earn more on your investments by enabling you to take advantage of opportunities that arise with brief windows in which to strike.
From this perspective, keeping some cash or investments in liquid, low-risk securities may prove to be a high-return proposition in the long run.
In some cases, it might be helpful to invest in convertible preferred stocks or convertible bonds, as long as you stay with established firms the way Buffett does.
Showing posts with label cash. Show all posts
Showing posts with label cash. Show all posts
Tuesday 13 April 2010
Thursday 8 April 2010
Cash Hoard – Boon Or Bane For Shareholders
EDUCATION | 16 MARCH 2010
Cash Hoard – Boon Or Bane For Shareholders
By Ernest Lim
 |
Imagine if you have S$100m in your bank account, what joys and problems would you face? I believe some of the joys would entail sacking your boss, living it extravagantly but problems would include the deployment of cash, as well as, fearing for your life if people are aware of your immense wealth.
If the above situation happens to companies with large cash holdings, the management would also face similar problems, especially on the issue of effective cash deployment. So for companies with a large cash hoard, is it a boon or a bane? Let’s delve into the pros and cons of maintaining a substantial cash hoard.
Advantages
Reflective of a company with strong business performance
One of the advantages is that a large cash hoard signals that the company seems to accumulate cash faster than it can deploy (assuming that the company is effectively deploying its cash but it is still accumulating).
Furthermore, it is also reflective of a good business performance as cash is derived from profitable operations.
Buffer against bad times
Cash can be used as a buffer against bad times or mistimed acquisitions. For example, during the recession in 2008/09, companies with large amounts of debt and little cash face refinancing difficulties and some even have problems paying off the loans when they are due. Ferrochina, ex Singapore listed firm in the manufacturing sector, is a case in point.
Moreover, cash serves as a safety net against unpredictable events. Companies which carry out acquisitions, joint ventures, or maiden expansions into new markets or geographies are likely to face their fair share of failures and difficulties. Some business ventures may not reach their desired results and may run into temporary losses. Cash can be used to cover the losses in such situations.
Business facilitator
Companies with cash holdings are also likely to be able to get favourable credit terms with suppliers and banks. This is apparent as suppliers and banks have to access the credit risk of the companies which they are doing business with and companies with a considerable amount of cash holdings would allay part of their credit concerns. This would aid in the business operations of the companies.
Flexibility for future growth
Cash also provides management with a myriad of options for future growth. For example, management can decide on the following options
- Look out for attractive acquisition targets either to expand horizontally or vertically along the value chain.
- Carry out capital expenditure such as to acquire land for future purpose, or expand their production capacity through buying more machines etc.
- Invest in listed companies purely for investment purposes.
Disadvantages
Dearth of attractive investment opportunities
One of the most obvious reasons for a large cash hoard is that management has exhausted attractive investment opportunities at the moment and is keeping cash for future opportunities whenever that may be. This does not benefit shareholders as holding substantial cash incurs an opportunity cost and also drag down the return generated by the companies. Besides, shareholders prefer companies to return cash or carry out share buybacks if there are no attractive investment opportunities by the companies.
Lack of long term planning
Some companies may not have the practice of planning for the long term. Thus, as they do not have a concrete idea of their cash requirements over the next three to five years, they would prefer to hold cash as this provide them with flexibility. Nonetheless, it is generally non ideal to invest in companies which do not execute long term planning, as “failure to plan means planning to fail”.
Agency costs
With substantial cash in the companies’ coffers, management may be tempted to use these funds to build their own empire by spending on non synergistic acquisitions and loss making projects, so as to boost their power, reputation and prestige.
Possibility of incurring suspicion and indignation from shareholders
If the cash hoard is increasing and management does not have concrete plans on the use of such funds, this may incur the suspicion on the authenticity of actual cash owned by the companies. For example, Oriental Century, a Singapore listed firm in the education sector, has a large amount of cash in its books. However, it is subsequently revealed that its Chief Executive Officer has allegedly inflated the cash holdings.
Another company, China Hongxing, a Singapore listed firm in the sports shoe and apparel sector, has been incurring the indignation of shareholders for more than a year by sitting on a large cash hoard, amounting to RMB3b at Dec 09, up from RMB1.9b at Dec 08. The collapse in its share price from the high of S$1.45 in Oct 07 to a low of S$0.055 in Mar 09 was due in part to investors’ angst and displeasure in China Hongxing management of cash. However, China Hongxing management has recently unveiled plans on how it would be deploying its cash.
Conclusion – evaluate against the overall context
To determine whether having a large cash hoard is beneficial to shareholders, shareholders have to evaluate against the following criteria:
- Companies’ existing and future incoming cash flows;
- Companies existing and future cash flow requirements (i.e. outflows);
- Stage of business cycles;
- Existing loan and interest repayments.
Thus, if the companies have concise plans to deploy their cash, either to satisfy outstanding loan repayments, or for synergistic acquisition purposes, or for capital expenditure in view of the recovery in the business cycles, then the cash hoard is a boon as it creates shareholder value.
Conversely, if management has no concrete plans to deploy the cash or to deploy them in reckless fashion, then, the cash hoard is a bane as it destroys shareholder value.
Once again, investors have to put on their thinking hats and do some work to reach a decision on whether the cash hoard is a boon or a bane for shareholders.
Ernest Lim currently works as an assistant treasury and investment manager. Prior to this role, he was with Legacy Capital Group Pte Ltd, a boutique asset management and private equity firm, as an investment manager since 2006. He received a Bachelor of Accountancy (Honours) from Nanyang Technological University in 2005. He is a Chartered Financial Analyst, as well as, a Certified Public Accountant Singapore. He is currently taking a short break before embarking on a new role.
http://www.sharesinv.com/articles/2010/03/16/cash-hoard-boon-bane-sharesholders/
http://www.sharesinv.com/articles/2010/03/16/cash-hoard-boon-bane-sharesholders/
Sunday 31 January 2010
Money market funds have become very popular alternative to bank deposit
A money market fund is a type of unit trust that invests in interest-bearing instruments issued by banks, government and companies when they want to borrow money.
These short-term instruments are
Money market funds have major advantages in comparison with other cash investments. For example:
This income is capitalised, or reinvested, which means the investor earns interest on interest.
Money market funds are ideal
When you invest in a money market acount, you should know the difference between the nominal and effective rate.
These short-term instruments are
- traded on the money market, and
- have a maturity of less than 12 months.
Money market funds have major advantages in comparison with other cash investments. For example:
- You gain access to money market instruments even though you invest only a small amount.
- The interest rate is higher than for a bank deposit, as you are part of a group that can bargain for the best wholesale rates.
- You can withdraw your money at any time, like a call deposit at a bank.
- Interest rate risk is largely eliminated because money market funds are allowed to invest only in instruments with an average term of not more than 90 days.
This income is capitalised, or reinvested, which means the investor earns interest on interest.
Money market funds are ideal
- for pensioners who must live on their interest income or
- for the creation of an emergency fund from which you can withdraw money at any time.
- to limit the risk of an investment portfolio in uncertain times or
- to phase in their funds.
When you invest in a money market acount, you should know the difference between the nominal and effective rate.
- The effective rate is the interest rate you will earn if your money is deposited for the whole year and all the interest is reinvested.
- The nominal rate is lower because this is the rate you earn every month before any reinvestment of interest is taken into account.
The 'safe' option of cash
Cash has always been seen as a fairly safe investment, and our forefathers were quite happy to put their money under the mattress and leave it there.
Today we realise that you cannot just put your money away and forget about it, because inflation will erode its value.
If you want a stable income, a bank deposit is still a valuable investment option.
However, money market funds have become a very popular alternative.
Today we realise that you cannot just put your money away and forget about it, because inflation will erode its value.
If you want a stable income, a bank deposit is still a valuable investment option.
However, money market funds have become a very popular alternative.
Saturday 30 January 2010
The calmer waters of interest-bearing investments: their risks and rewards
The interest-bearing investments include:
The focus of interest-bearing investments is not on the appreciation (increase) of the capital you have invested, but rather on the provision of a steady interest income - often at a fixed rate.
While shares offer you higher returns at a higher risk, interest-bearing investments offer you lower returns at a lower risk, making them a safe haven for many investors.
But this safe asset class is not safe from inflation.
Interest-bearing investments often do not generate the kind of return that beats inflation, and it is very important to remember that interest income is taxable. After taking tax into account, the return on interest-bearing investments often struggles to beat the inflation rate.
The reason for this is simple. Interest-bearing investments are normally money you lend to a bank, government, company or other institution with the undertaking that this exact amount will be paid back after a period of time.
In return for this, you earn interest.
Since you only get the same amount back after a couple of months or years, that amount is usually worth less as a result of inflation.
Your only real benefit is the income that you receive.
Interest-bearing investments also hold other risks.
Interest-bearing investments do, however, play an important part in an investment portfolio. Although inflation will still erode the capital value of your investment, these investments do have advantages, including:
- cash
- bonds
- the money market securities.
The focus of interest-bearing investments is not on the appreciation (increase) of the capital you have invested, but rather on the provision of a steady interest income - often at a fixed rate.
While shares offer you higher returns at a higher risk, interest-bearing investments offer you lower returns at a lower risk, making them a safe haven for many investors.
But this safe asset class is not safe from inflation.
Interest-bearing investments often do not generate the kind of return that beats inflation, and it is very important to remember that interest income is taxable. After taking tax into account, the return on interest-bearing investments often struggles to beat the inflation rate.
The reason for this is simple. Interest-bearing investments are normally money you lend to a bank, government, company or other institution with the undertaking that this exact amount will be paid back after a period of time.
In return for this, you earn interest.
Since you only get the same amount back after a couple of months or years, that amount is usually worth less as a result of inflation.
Your only real benefit is the income that you receive.
Interest-bearing investments also hold other risks.
- This asset class is subject to the ups and downs of the interest rate cycle. As interest rates increase or decrease, your cash flow can be affected - unless you have a fixed interest rate.
- Furthermore, you should beware of institutions with credit risk. A high interest rate is not everything: you must also be sure that your capital will be paid back.
Interest-bearing investments do, however, play an important part in an investment portfolio. Although inflation will still erode the capital value of your investment, these investments do have advantages, including:
- offering you a relatively safe and predictable income.
- offering you less risk and volatility than an investment in equities
- offering diversification in your portfolio in case stock markets collapse
- giving you instant access to cash when you need it.
Cash - low risk
Cash is one investment from which you can never hope to make a fortune, althoug it can safeguard you against losing one.
Cash investments, including bank deposits and money market accounts,
But cash also carries risk. There is no guarantee that your capital sum will be protected against inflation, as this investment does not have any inherent growth potential.
Cash investments, including bank deposits and money market accounts,
- offer you the assurance of a regular interest income and
- knowing your capital will not be subjected to huge external fluctuations.
But cash also carries risk. There is no guarantee that your capital sum will be protected against inflation, as this investment does not have any inherent growth potential.
Friday 27 November 2009
Cash: The real enemy of investors is not fluctuation of principal, it is inflation!
Many investors confuse safety of principal with a "sure thing investment." Cash accounts provide investors with peace of mind because their principal does not fluctuate in value and because interest is added to the account on a periodic basis. The institution providing the savings vehicle invests the money deposited by the investor in loans and bonds. They take the dual risks of volatility and loss of capital - not the investor. Unfortunately, investor peace of mind is an illusion, because the real enemy is not fluctuation of principal, it is inflation! And "cash" investments do not keep pace with inflation! As inflation robs investors of their purchasing power they must invade principal to buy the goods and services they need to live. As the years go by, the investors' peace of mind is replaced by fear as they continually dip into their principal to pay for lifestyle expenses that rise with inflation.
In fact, cash flunks one of the most important tests we set for our perfect income investment. In exchange for safety of principal and liquidity, the returns on cash are generally very low. In fact, at current rates, the return on most cash alternatives isn't even as high as the rate of inflation, as measured by the Consumer Price Index (CPI).
On December 31, 2003, the average yield on a 30-day Treasury bill was a paltry 0.85 percent while the annual rate of change in the CPI was 1.88 percent. In other words, the interest on your money, would not be sufficient to replace the purchasing power you're losing to inflation.
Even if you think cash passes the safety of principal test because your principal does not fluctuate in value, it fails three other important safety tests.
The more you study the inflation problem, the more you realize how important it is to a successful retirement plan. Inflation has been pretty tame over the past 10 years, averaging only 2.75 percent per year. Don't be lulled into a false sense of security and allow yourself to think that inflation is not going to be a big problem for you in the future.
In the 1970s inflation averaged just over 7.4%. By the 1990s inflation had moderated to an average of just over 2.9%. Still, the average inflation rate for the entire 30-year period from 1972 through 2002 was 5.12%.
Just a small increase can be crushing to retirees. You would need to invest a lot more money initially in a cash investment to provide enough interest to be reinvested against the day when you need to take more income to keep up with rising costs.
Inflation is the Retired Person's Greatest Enemy
1972-2002 (30 years) Average inflation rate 5.12%
1982-2002 (20 years) Average inflation rate 3.36%
1992-2002 (10 years) Average inflation rate 2.75%
Example:
Let's say you had an income need of $3,000 per month and you noticed that you could buy a five-year CD with a current yield of 4% (a generous assumption based on current yields). To generate an income of $3,000 per month or $36,000 per year, you would need to deposit $900,000 in the bank.
The first year everything seems to work well, but in the second year you notice two problems:
1. You had to pay taxes on your interest income, and you had not factored that into the question. Where do you get the tax money?
2. Your living costs are rising, and you forgot to factor in inflation. If inflation averages just 3% for the first year, your annual expenses would increase by an additional $1,080, compounding your income need. After only the first year, you would have to start liquidating principal to buy the same goods, and services you enjoyed the year before.
Safe but Sorry
Over the years we have seen many people make the same big mistake - they opt for the safety of principal that cash investments offer and ignore inflation risk. Inflation robs them of the purchasing power of cash; this illusion of safety would cost dearly. When interest rates drop, they maybe forced to dip into their original capital. The more principal taken out, the less income will be produced putting them on a slippery slope.
The classic problems of:
Bonds start out with a little more income for each dollar invested, but suffer the same defects that cash investments do. And, although it may not be widely understood by most investors, bonds can also suffer from high volatility and risk under the right circumstances.
Is there another option to meet your income needs without impairing the capital base? We shall take a look at the difference dividend paying stocks can make. As an investor in dividend-paying stocks, you not only get to keep more of what you earn from dividends becasue of lower taxes, but it's likely your dividend income and value will increase over time to keep you with inflation. These exciting fundamental benefits are also available in dividend-paying stocks for growth.
- First, the safety of cash begins to look suspect if you're losing the true value of your money - the ability to buy the things you need - because of inflation.
- Second, since the yield is so low, the income generated by cash is not sufficient to buy the goods and services you need, which will force you to liquidate your principal.
- Finally, the false illusion of safety is compounded because the low yield on cash is further reduced by taxes. Worst yet, you will pay tax at your highest marginal rate. Unfortunately the combination of a high tax rate and a low yield only increase your need to liquidate assets.
1982-2002 (20 years) Average inflation rate 3.36%
1992-2002 (10 years) Average inflation rate 2.75%
2. Your living costs are rising, and you forgot to factor in inflation. If inflation averages just 3% for the first year, your annual expenses would increase by an additional $1,080, compounding your income need. After only the first year, you would have to start liquidating principal to buy the same goods, and services you enjoyed the year before.
Safe but Sorry
Over the years we have seen many people make the same big mistake - they opt for the safety of principal that cash investments offer and ignore inflation risk. Inflation robs them of the purchasing power of cash; this illusion of safety would cost dearly. When interest rates drop, they maybe forced to dip into their original capital. The more principal taken out, the less income will be produced putting them on a slippery slope.
The classic problems of:
- low yield,
- high taxes and
- no inflation protection
Bonds start out with a little more income for each dollar invested, but suffer the same defects that cash investments do. And, although it may not be widely understood by most investors, bonds can also suffer from high volatility and risk under the right circumstances.
Is there another option to meet your income needs without impairing the capital base? We shall take a look at the difference dividend paying stocks can make. As an investor in dividend-paying stocks, you not only get to keep more of what you earn from dividends becasue of lower taxes, but it's likely your dividend income and value will increase over time to keep you with inflation. These exciting fundamental benefits are also available in dividend-paying stocks for growth.
CDs, Savings and Money Market Accounts
The big attraction of the choices in this group is their safety of principal. In fact, they are considered so safe that they are generally lumped together as an asset class called "Cash/Cash Equivalents." For the purpose of this article, let's call them all "cash".
The main attraction of cash is simple - the value of the principal does not fluctuate and may even be guaranteed depending on the amount of the investment. Put a dollar in, and you'll get a dollar back, plus interest. In addition, the assets in cash group can generally be "cashed in" at full value on short notice (although CDs may have meaningful early surrender penalties). No matter what gyrations the stock market or interest rates are going through , the value of these assets stays the same. Most financial planners will recommend that you have enough money salted away in cash/cash equivalents to cover three to six months' living expenses, plus an amount to cover any known major outlays you'll have to make in the next year or two. This group of assets can also add stability to your portfolio because their value is stable. All in all, cash plays a key role in building a portfolio as a sound foundation for funding emergencies or contingent expenses - but not for income!
The main attraction of cash is simple - the value of the principal does not fluctuate and may even be guaranteed depending on the amount of the investment. Put a dollar in, and you'll get a dollar back, plus interest. In addition, the assets in cash group can generally be "cashed in" at full value on short notice (although CDs may have meaningful early surrender penalties). No matter what gyrations the stock market or interest rates are going through , the value of these assets stays the same. Most financial planners will recommend that you have enough money salted away in cash/cash equivalents to cover three to six months' living expenses, plus an amount to cover any known major outlays you'll have to make in the next year or two. This group of assets can also add stability to your portfolio because their value is stable. All in all, cash plays a key role in building a portfolio as a sound foundation for funding emergencies or contingent expenses - but not for income!
Thursday 24 September 2009
Biggest Market Opportunity: Cash? (No, I'm Not Insane)
Biggest Market Opportunity: Cash? (No, I'm Not Insane)
By Alex Dumortier, CFA
September 23, 2009
What sort of insanity is this? How could cash be an opportunity at a time when three-month T-bills yield less than 10 basis points? No one gets excited earning virtually nothing on their cash balances, but stock investors should consider future opportunities in addition to existing choices: It's not about what you're not earning on the cash today, it's about earning premium returns on the investments you'll be able to make with that cash tomorrow.
Cash needn't be an anchor
In the words of super-investor Seth Klarman: "Why should the immediate opportunity set be the only one considered, when tomorrow's may well be considerably more fertile than today's?" At the head of the Baupost Group, a multi-billion dollar investment partnership, Klarman employs a value-oriented strategy, achieving exceptional performance in spite of -- or rather, because of -- the fact that he frequently holds significant amounts of cash. For example, on October 31, 1999, a few months before the tech bubble began to collapse, his Baupost Fund was approximately one third in cash.
Over the "lost decade" spanning 1999 through 2008, Klarman smashed the market with a 15.9% average annualized return net of fees and incentives versus a (1.4%) annualized loss for the S&P 500.
Don't go all in (cash or equities)
Let me be quite clear: I'm not advocating that you liquidate all your stocks and go all into cash; the market's current valuation simply does not warrant that sort of drastic action. Conversely, it shouldn't compel you to raise your broad equity exposure, either.
As I noted last week, the market doesn't look cheap right now: Based on data compiled by Professor Robert Shiller of Yale, at yesterday's closing value of 1,071.66, the S&P 500 is valued at over 19 times its cyclically adjusted earnings, compared to a long-term historical average of 16.3. Based on average inflation-adjusted earnings, the cyclically adjusted P/E ratio is one of the only consistently useful market valuation indicators.
As prices increase, so does your risk
All other things equal, as share prices rise, stocks will represent a larger percentage of your assets; however, logic dictates you should actually seek to ratchet down your equity exposure under those circumstances. As stock prices rise, expected future returns decline (again, all other factors remaining constant), making stocks relatively less attractive. Another way to express this is that as stock prices increase, so does the risk associated with owning stocks.
That risk may simply be earning sub-par returns or, in the worst case, suffering capital losses. Extremes in market valuations offer the best illustration of this principle: Owning a basket of Nasdaq stocks in March 2000: a high-risk or low-risk strategy? How about buying Japanese stocks in December 1989, with the Nikkei Index nearing 39,000 (nearly 20 years on, the same index trades at less than 10,500).
Don't misinterpret Buffett's words
So what are we to make of Berkshire Hathaway (BRK-B) CEO Warren Buffett's words when he told CNBC on July 24th: "I would much rather own equities at 9,000 on the Dow than have a long investment in government bonds or a continuously rolling investment in short-term money"? (Investors must have concluded the same thing, sending the Dow 8% higher since then.)
First, with just 30 component stocks, the Dow isn't a broad-market index; it's a blue-chip index. The stocks of high-quality companies have underperformed the broader market in the rally from the March market low, which has left them relatively undervalued. This is reflected in the Dow's 14 price-to-earnings multiple, against 17 for the wider S&P 500.
Buying pieces of businesses vs. owning the market
Second, keep in mind that Buffett likes to own pieces of high-quality businesses, not the whole market. As I mentioned above, there is reason to believe that there is still opportunity left in the higher-quality segment of the market. The following table contains six companies that trade with a free-cash-flow yield above 10% -- i.e., they're priced at less than 10 times trailing free cash flow (these are not investment recommendations):
Company Sector
Free-Cash-Flow Yield*
General Electric (NYSE: GE)
Conglomerates
47.3%
UnitedHealth Group (NYSE: UNH)
Health care
11.7%
Bristol-Myers Squibb (NYSE: BMY)
Health care
10.6%
Raytheon (NYSE: RTN)
Industrial goods
10.5%
Altria Group (NYSE: MO)
Consumer goods
11.5%
Time Warner (NYSE: TWX)
Services
25.9%
*Based on TTM free cash flow and closing stock prices on September 21, 2009.
Source: Capital IQ, a division of Standard & Poor's, Yahoo! Finance.
Summing up: What to do from here
To sum up:
If, like Buffett, you have identified high-quality businesses that are undervalued, there is nothing wrong with buying them now.
However, if you are mainly an index investor, it is probably ill-conceived to increase your exposure to stocks right now.
Either way, whether you are a stockpicker or an index investor, there is nothing wrong with holding on to some cash right now -- not for its own sake -- but to take advantage of better stock prices at a later date.
Morgan Housel has identified three high-quality companies that are still cheap.
http://www.fool.com/investing/value/2009/09/23/biggest-market-opportunity-cash-no-im-not-insane.aspx
By Alex Dumortier, CFA
September 23, 2009
What sort of insanity is this? How could cash be an opportunity at a time when three-month T-bills yield less than 10 basis points? No one gets excited earning virtually nothing on their cash balances, but stock investors should consider future opportunities in addition to existing choices: It's not about what you're not earning on the cash today, it's about earning premium returns on the investments you'll be able to make with that cash tomorrow.
Cash needn't be an anchor
In the words of super-investor Seth Klarman: "Why should the immediate opportunity set be the only one considered, when tomorrow's may well be considerably more fertile than today's?" At the head of the Baupost Group, a multi-billion dollar investment partnership, Klarman employs a value-oriented strategy, achieving exceptional performance in spite of -- or rather, because of -- the fact that he frequently holds significant amounts of cash. For example, on October 31, 1999, a few months before the tech bubble began to collapse, his Baupost Fund was approximately one third in cash.
Over the "lost decade" spanning 1999 through 2008, Klarman smashed the market with a 15.9% average annualized return net of fees and incentives versus a (1.4%) annualized loss for the S&P 500.
Don't go all in (cash or equities)
Let me be quite clear: I'm not advocating that you liquidate all your stocks and go all into cash; the market's current valuation simply does not warrant that sort of drastic action. Conversely, it shouldn't compel you to raise your broad equity exposure, either.
As I noted last week, the market doesn't look cheap right now: Based on data compiled by Professor Robert Shiller of Yale, at yesterday's closing value of 1,071.66, the S&P 500 is valued at over 19 times its cyclically adjusted earnings, compared to a long-term historical average of 16.3. Based on average inflation-adjusted earnings, the cyclically adjusted P/E ratio is one of the only consistently useful market valuation indicators.
As prices increase, so does your risk
All other things equal, as share prices rise, stocks will represent a larger percentage of your assets; however, logic dictates you should actually seek to ratchet down your equity exposure under those circumstances. As stock prices rise, expected future returns decline (again, all other factors remaining constant), making stocks relatively less attractive. Another way to express this is that as stock prices increase, so does the risk associated with owning stocks.
That risk may simply be earning sub-par returns or, in the worst case, suffering capital losses. Extremes in market valuations offer the best illustration of this principle: Owning a basket of Nasdaq stocks in March 2000: a high-risk or low-risk strategy? How about buying Japanese stocks in December 1989, with the Nikkei Index nearing 39,000 (nearly 20 years on, the same index trades at less than 10,500).
Don't misinterpret Buffett's words
So what are we to make of Berkshire Hathaway (BRK-B) CEO Warren Buffett's words when he told CNBC on July 24th: "I would much rather own equities at 9,000 on the Dow than have a long investment in government bonds or a continuously rolling investment in short-term money"? (Investors must have concluded the same thing, sending the Dow 8% higher since then.)
First, with just 30 component stocks, the Dow isn't a broad-market index; it's a blue-chip index. The stocks of high-quality companies have underperformed the broader market in the rally from the March market low, which has left them relatively undervalued. This is reflected in the Dow's 14 price-to-earnings multiple, against 17 for the wider S&P 500.
Buying pieces of businesses vs. owning the market
Second, keep in mind that Buffett likes to own pieces of high-quality businesses, not the whole market. As I mentioned above, there is reason to believe that there is still opportunity left in the higher-quality segment of the market. The following table contains six companies that trade with a free-cash-flow yield above 10% -- i.e., they're priced at less than 10 times trailing free cash flow (these are not investment recommendations):
Company Sector
Free-Cash-Flow Yield*
General Electric (NYSE: GE)
Conglomerates
47.3%
UnitedHealth Group (NYSE: UNH)
Health care
11.7%
Bristol-Myers Squibb (NYSE: BMY)
Health care
10.6%
Raytheon (NYSE: RTN)
Industrial goods
10.5%
Altria Group (NYSE: MO)
Consumer goods
11.5%
Time Warner (NYSE: TWX)
Services
25.9%
*Based on TTM free cash flow and closing stock prices on September 21, 2009.
Source: Capital IQ, a division of Standard & Poor's, Yahoo! Finance.
Summing up: What to do from here
To sum up:
If, like Buffett, you have identified high-quality businesses that are undervalued, there is nothing wrong with buying them now.
However, if you are mainly an index investor, it is probably ill-conceived to increase your exposure to stocks right now.
Either way, whether you are a stockpicker or an index investor, there is nothing wrong with holding on to some cash right now -- not for its own sake -- but to take advantage of better stock prices at a later date.
Morgan Housel has identified three high-quality companies that are still cheap.
http://www.fool.com/investing/value/2009/09/23/biggest-market-opportunity-cash-no-im-not-insane.aspx
Monday 27 April 2009
'Nothing is an all-the-time good investment. Certainly not cash'
'Nothing is an all-the-time good investment. Certainly not cash'
People have been going back to risk and leaving the bomb shelters.
By James Bartholomew
Last Updated: 7:10AM BST 23 Apr 2009
I have to admit that I find the extreme ups and downs in the markets in recent months rather exciting. I am sorry that fortunes have been lost and people have suffered. I myself have lost a considerable amount.
But this has been exciting in a similar way, I imagine, as the view of London burning in the blitz was once thrilling for my mother when she recklessly went to the roof of Broadcasting House, where she was working, to have a look.
It is a jolly sight more fun, to be sure, when things are going well and they have certainly been a lot better since the rally started early last month.
I have had an extraordinary time with my shares in the pub-owning company, Enterprise Inns. Some readers may remember that 11 weeks ago, I wrote here, "I don't normally manage to lose money quite so quickly…"
I had bought shares in Enterprise at 69.75p. By the end of the week, they had halved. They reached a low of 32p.
Then they stabilised and eventually rose somewhat. But at the beginning of the week before last, I was still nursing a loss. Then, suddenly, whoosh! Up they went, leaping upward like a drug-enhanced mountain goat. A 15pc rise, then another 20pc. Out of the blue, I found myself in profit and still climbing.
The shares zoomed up to over 100p. They then fell back hard but got another lease of life. Having failed to buy more when they had been 32p, I found the courage to buy again when they were 93.5p.
There is human nature for you. As to whether this further purchase was wise, you can find out if you go to the business section of the main paper and look at the stock market prices under Travel and Leisure. They were trading at 117p on Monday.
The amazing downs and ups of Enterprise Inns reflect the abrupt return, since early March, of the appetite for risk. My defensive shares, such as Telecom Plus, a utility provider, have been shunned.
But shares that were heavily sold down because the companies are cyclical or heavily indebted, revived strongly. I also have shares in Tolent, a building company. It has performed like an investment Lazarus, leaving death's door at high speed.
Meanwhile, my investment in yen, through bonds, has done badly in the last couple of months. The yen has weakened precisely for the same reason as Enterprise Inns strengthened.
People have been going back to risk and leaving the bomb shelters. I have lightened my holdings in the yen, at least for the time being. This is because my view of what is going to happen in the economy and to investments has shifted a bit.
My rough idea, currently, of how things will pan out is this:
People have been going back to risk and leaving the bomb shelters.
By James Bartholomew
Last Updated: 7:10AM BST 23 Apr 2009
I have to admit that I find the extreme ups and downs in the markets in recent months rather exciting. I am sorry that fortunes have been lost and people have suffered. I myself have lost a considerable amount.
But this has been exciting in a similar way, I imagine, as the view of London burning in the blitz was once thrilling for my mother when she recklessly went to the roof of Broadcasting House, where she was working, to have a look.
It is a jolly sight more fun, to be sure, when things are going well and they have certainly been a lot better since the rally started early last month.
I have had an extraordinary time with my shares in the pub-owning company, Enterprise Inns. Some readers may remember that 11 weeks ago, I wrote here, "I don't normally manage to lose money quite so quickly…"
I had bought shares in Enterprise at 69.75p. By the end of the week, they had halved. They reached a low of 32p.
Then they stabilised and eventually rose somewhat. But at the beginning of the week before last, I was still nursing a loss. Then, suddenly, whoosh! Up they went, leaping upward like a drug-enhanced mountain goat. A 15pc rise, then another 20pc. Out of the blue, I found myself in profit and still climbing.
The shares zoomed up to over 100p. They then fell back hard but got another lease of life. Having failed to buy more when they had been 32p, I found the courage to buy again when they were 93.5p.
There is human nature for you. As to whether this further purchase was wise, you can find out if you go to the business section of the main paper and look at the stock market prices under Travel and Leisure. They were trading at 117p on Monday.
The amazing downs and ups of Enterprise Inns reflect the abrupt return, since early March, of the appetite for risk. My defensive shares, such as Telecom Plus, a utility provider, have been shunned.
But shares that were heavily sold down because the companies are cyclical or heavily indebted, revived strongly. I also have shares in Tolent, a building company. It has performed like an investment Lazarus, leaving death's door at high speed.
Meanwhile, my investment in yen, through bonds, has done badly in the last couple of months. The yen has weakened precisely for the same reason as Enterprise Inns strengthened.
People have been going back to risk and leaving the bomb shelters. I have lightened my holdings in the yen, at least for the time being. This is because my view of what is going to happen in the economy and to investments has shifted a bit.
My rough idea, currently, of how things will pan out is this:
- first, the "quantitative easing" will work in ending the economic decline. The stock market will respond positively and go higher.
- Second, after a lag, inflation will pick up strongly. This will cause a flight to gold and inflation index-linked government stocks (and perhaps the yen).
- Third, in response to the inflation, interest rates will rise which will hurt shares somewhat – though it is difficult to tell how much.
- And finally, when inflation seems to be coming down and interest rates fall back again, there will be big rises in shares and property.
This forecast could easily be partly or completely wrong. But even if this guess/forecast of the future is right, the timing is uncertain. How long will the lag be before inflation? How much will people anticipate it and buy gold beforehand? It is hard to predict.
I have already bought some gold in the form of units in an exchange traded fund, ETFS Physical Gold and I have bought some Treasury 2.5pc 2024 inflation index-linked stock. But, at the time of writing, they have done nothing.
Yes, there is a risk of hyper-inflation, but a rush for inflation-protection investments may not really get going until the danger is clear and present. In the meantime, I suspect that shares are the investments that may do best.
That is why I bought extra shares in Enterprise Inns. I have also increased my holding in Home Products, a Thai company that runs DIY stores.
Its latest results were surprisingly good and the shares have risen by a third in the last two months but even at the price I paid, 4.59 baht, the shares have a historic dividend yield of 7.5pc.
I had better add that, of course, I could be completely wrong. Many people think this is a bear market rally. We each must make our own judgements and arrange our investments accordingly.
But in these financially dangerous times, I believe that anyone with savings should be thinking hard about it. Nothing is an all-the-time good investment. Certainly not cash.
http://www.telegraph.co.uk/finance/personalfinance/investing/5202598/Nothing-is-an-all-the-time-good-investment.-Certainly-not-cash.html
Sunday 1 March 2009
You've Sold Your Stocks. Now What?
You've Sold Your Stocks. Now What?
Thursday, February 26, 2009
provided by
Back in the summer of 2007, Ben Mickus, a New York architect, had a bad feeling. He and his wife, Taryn, had invested in the stock market and had done well, but now that they had reached their goal of about $200,000 for a down payment on a house, Mr. Mickus was unsettled. “Things had been very erratic, and there had been a lot of press about the market becoming more chaotic,” he said.
In October of that year they sat down for a serious talk. Ms. Mickus had once lost a lot of money in the tech bubble, and the prospect of losing their down payment made Mr. Mickus nervous. “I wanted to pull everything out then; Taryn wanted to keep it all in,” he said. They compromised, cashing in 60 percent of their stocks that fall — just before the Dow began its slide.
A couple of months later, with the market still falling, Ms. Mickus was convinced that her husband was right, and they sold the remainder of their stocks. Their down payment was almost completely preserved. Ms. Mickus said that in private they had “been feeling pretty smug about it.”
“Now our quandary is, what do we do going forward?” Ms. Mickus said.
Having $200,000 in cash is a problem many people would like to have. But there is yet another worry: it’s no use taking money out of the market at the right time unless it is put back in at the right time. So to get the most from their move, the Mickuses will have to be right twice.
“Market timing requires two smart moves,” said Bruce R. Barton, a financial planner in San Jose, Calif. “Getting out ahead of a drop. And getting back in before the recovery.”
It’s a challenge many investors face, judging from the amount of cash on the sidelines. According to Fidelity Investments, in September 2007 money market accounts made up 15 percent of stock market capitalization in the United States. By December 2008, it was 40 percent.
“In 2008 people took money out of equities and took money out of bond funds,” said Steven Kaplan, a professor at the Booth School of Business at the University of Chicago.
He cited figures showing that in 2007 investors put $93 billion into equity funds. By contrast, in 2008 they took out $230 billion.
Michael Roden, a consultant to the Department of Defense from the Leesburg, Va., area, joined the ranks of the cash rich after a sense of déjà vu washed over him in August 2007, as the markets continued their steep climb. “I had taken quite a bath when the tech bubble burst,” he said. “I would never let that happen again.”
With his 2002 drubbing in mind, he started with some profit taking in the summer of 2007, but as the market turned he kept liquidating his investments in an orderly retreat. But he was not quite fast enough.
“When Bear Stearns went under I realized something was seriously wrong,” he said. The market was still in the 12,000 range at that time. When the Federal Reserve announced it would back Bear Stearns in March 2008, there was a brief market rebound. “I used that rally to get everything else out,” he said.
Mr. Roden said he had taken a 6 percent loss by not liquidating sooner, which still put him ahead of the current total market loss. Now he has about $130,000, with about 10 percent in gold mutual funds, 25 percent in foreign cash funds and the rest in a money market account.
“I am looking for parts of the economy where business is not impaired by the credit crunch or changes in consumer behavior,” he said. He is cautiously watching the energy markets, he said, but his chief strategy is “just trying not to lose money.”
As chief financial officer of Dewberry Capital in Atlanta, a real estate firm managing two million square feet of offices, stores and apartments, Steve Cesinger witnessed the financial collapse up close. Yet it was just a gut feeling that led him to cash out not only 95 percent of his personal equities, but also those of his firm in April 2007.
“I spent a lot of time trying to figure out what was happening in the financial industry, and I came to the conclusion that people weren’t fessing up,” he said. “In fact, they were going the other way.”
Now, he said, “We have cash on our statement, and it’s hard to know what to do with it.”
Having suffered through a real estate market crash in Los Angeles in the early 1990s, Mr. Cesinger is cautious to the point of re-examining the banks where he deposits his cash. “Basically, I’m making sure it’s somewhere it won’t disappear,” he said.
The F.D.I.C. assurance doesn’t give him “a lot of warm and fuzzy,” Mr. Cesinger said. “My recollection is, if the institution goes down, it can take you a while to get your money out. It doesn’t help to know you’ll get it one day if you have to pay your mortgage today.”
His plan is to re-enter the market when it looks safe. Very safe. “I would rather miss the brief rally, be late to the party and be happy with not a 30 percent return, but a bankable 10 percent return,” he said.
Not everyone is satisfied just to stem losses. John Branch, a business consultant in Los Angeles, said his accounts were up 100 percent from short-selling — essentially betting against recovery. “The real killer was, I missed the last leg down on this thing,” Mr. Branch said. “If I hadn’t missed it, I would be up 240 percent.”
Mr. Branch said he had seen signs of a bubble in the summer of 2007 and liquidated his stocks, leaving him with cash well into six figures. Then he waited for his chance to begin shorting. The Dow was overvalued, he said, and ripe for a fall.
Shorting is a risky strategy, which Mr. Branch readily admits. He said he had tried to limit risk by trading rather than investing. He rises at 4:30 a.m., puts his money in the market and sets up his electronic trading so a stock will automatically sell if it falls by one-half of 1 percent. “If it turns against me, I am out quickly,” he said. By 8, he is off to his regular job.
Because Mr. Branch switches his trades daily based on which stocks are changing the fastest, he cannot say in advance where he will put his money.
And if he did know, he’d rather not tell. “I hate giving people financial advice,” he said. “If they make money they might say thank you; if they miss the next run-up, they hate you.”
http://finance.yahoo.com/retirement/article/106655/You've-Sold-Your-Stocks-Now-What;_ylt=At2xBlsXPsWlCuNeEFN6PP5O7sMF?
Thursday, February 26, 2009
provided by
Back in the summer of 2007, Ben Mickus, a New York architect, had a bad feeling. He and his wife, Taryn, had invested in the stock market and had done well, but now that they had reached their goal of about $200,000 for a down payment on a house, Mr. Mickus was unsettled. “Things had been very erratic, and there had been a lot of press about the market becoming more chaotic,” he said.
In October of that year they sat down for a serious talk. Ms. Mickus had once lost a lot of money in the tech bubble, and the prospect of losing their down payment made Mr. Mickus nervous. “I wanted to pull everything out then; Taryn wanted to keep it all in,” he said. They compromised, cashing in 60 percent of their stocks that fall — just before the Dow began its slide.
A couple of months later, with the market still falling, Ms. Mickus was convinced that her husband was right, and they sold the remainder of their stocks. Their down payment was almost completely preserved. Ms. Mickus said that in private they had “been feeling pretty smug about it.”
“Now our quandary is, what do we do going forward?” Ms. Mickus said.
Having $200,000 in cash is a problem many people would like to have. But there is yet another worry: it’s no use taking money out of the market at the right time unless it is put back in at the right time. So to get the most from their move, the Mickuses will have to be right twice.
“Market timing requires two smart moves,” said Bruce R. Barton, a financial planner in San Jose, Calif. “Getting out ahead of a drop. And getting back in before the recovery.”
It’s a challenge many investors face, judging from the amount of cash on the sidelines. According to Fidelity Investments, in September 2007 money market accounts made up 15 percent of stock market capitalization in the United States. By December 2008, it was 40 percent.
“In 2008 people took money out of equities and took money out of bond funds,” said Steven Kaplan, a professor at the Booth School of Business at the University of Chicago.
He cited figures showing that in 2007 investors put $93 billion into equity funds. By contrast, in 2008 they took out $230 billion.
Michael Roden, a consultant to the Department of Defense from the Leesburg, Va., area, joined the ranks of the cash rich after a sense of déjà vu washed over him in August 2007, as the markets continued their steep climb. “I had taken quite a bath when the tech bubble burst,” he said. “I would never let that happen again.”
With his 2002 drubbing in mind, he started with some profit taking in the summer of 2007, but as the market turned he kept liquidating his investments in an orderly retreat. But he was not quite fast enough.
“When Bear Stearns went under I realized something was seriously wrong,” he said. The market was still in the 12,000 range at that time. When the Federal Reserve announced it would back Bear Stearns in March 2008, there was a brief market rebound. “I used that rally to get everything else out,” he said.
Mr. Roden said he had taken a 6 percent loss by not liquidating sooner, which still put him ahead of the current total market loss. Now he has about $130,000, with about 10 percent in gold mutual funds, 25 percent in foreign cash funds and the rest in a money market account.
“I am looking for parts of the economy where business is not impaired by the credit crunch or changes in consumer behavior,” he said. He is cautiously watching the energy markets, he said, but his chief strategy is “just trying not to lose money.”
As chief financial officer of Dewberry Capital in Atlanta, a real estate firm managing two million square feet of offices, stores and apartments, Steve Cesinger witnessed the financial collapse up close. Yet it was just a gut feeling that led him to cash out not only 95 percent of his personal equities, but also those of his firm in April 2007.
“I spent a lot of time trying to figure out what was happening in the financial industry, and I came to the conclusion that people weren’t fessing up,” he said. “In fact, they were going the other way.”
Now, he said, “We have cash on our statement, and it’s hard to know what to do with it.”
Having suffered through a real estate market crash in Los Angeles in the early 1990s, Mr. Cesinger is cautious to the point of re-examining the banks where he deposits his cash. “Basically, I’m making sure it’s somewhere it won’t disappear,” he said.
The F.D.I.C. assurance doesn’t give him “a lot of warm and fuzzy,” Mr. Cesinger said. “My recollection is, if the institution goes down, it can take you a while to get your money out. It doesn’t help to know you’ll get it one day if you have to pay your mortgage today.”
His plan is to re-enter the market when it looks safe. Very safe. “I would rather miss the brief rally, be late to the party and be happy with not a 30 percent return, but a bankable 10 percent return,” he said.
Not everyone is satisfied just to stem losses. John Branch, a business consultant in Los Angeles, said his accounts were up 100 percent from short-selling — essentially betting against recovery. “The real killer was, I missed the last leg down on this thing,” Mr. Branch said. “If I hadn’t missed it, I would be up 240 percent.”
Mr. Branch said he had seen signs of a bubble in the summer of 2007 and liquidated his stocks, leaving him with cash well into six figures. Then he waited for his chance to begin shorting. The Dow was overvalued, he said, and ripe for a fall.
Shorting is a risky strategy, which Mr. Branch readily admits. He said he had tried to limit risk by trading rather than investing. He rises at 4:30 a.m., puts his money in the market and sets up his electronic trading so a stock will automatically sell if it falls by one-half of 1 percent. “If it turns against me, I am out quickly,” he said. By 8, he is off to his regular job.
Because Mr. Branch switches his trades daily based on which stocks are changing the fastest, he cannot say in advance where he will put his money.
And if he did know, he’d rather not tell. “I hate giving people financial advice,” he said. “If they make money they might say thank you; if they miss the next run-up, they hate you.”
http://finance.yahoo.com/retirement/article/106655/You've-Sold-Your-Stocks-Now-What;_ylt=At2xBlsXPsWlCuNeEFN6PP5O7sMF?
Saturday 14 February 2009
Stashing Your Cash: Mattress Or Market?
Stashing Your Cash: Mattress Or Market?
by Lisa Smith (Contact Author Biography)
When stock markets become volatile, it makes investors nervous. In many cases, this prompts them to take money out of the market and keep it in cash. Cash can be seen, felt and spent at will and for most people, having money in hand feels safe. But how safe is it really? Read on to find out whether your money is safer in the market or under your mattress.
All Hail Cash?
There are definitely some benefits to holding cash. When the stock market is in free fall, holding cash helps you avoid further losses. Even if the stock market doesn't fall on a particular day, there is always the potential that it could have fallen. This possibility is known as systematic risk, and it can be completely avoided by holding cash.
Cash is also psychologically soothing. During troubled times, you can see and touch cash. Unlike the rapidly dwindling balance in your brokerage account, cash will still be in your pocket or in your bank account in the morning.
However, while moving to cash might feel good mentally and help you avoid short-term stock market volatility, it is unlikely to be a wise move over the long term.
A Loss In Not a Loss ...
When your money is in the stock market and the market is down, you may feel like you've lost money, but you really haven't. At this point, it's a paper loss. A turnaround in the market can put you right back to breakeven and maybe even put a profit in your pocket. If you sell your holdings and move to cash, you lock in your losses. They go from being paper losses to being real losses with no hope of recovery. While paper losses don't feel good, long-term investors accept that the stock market rises and falls. Maintaining your positions when the market is down is the only way that your portfolio will have a chance to benefit when the market rebounds. (For more insight, see How are realized profits different from unrealized, or so-called "paper", profits?)
Inflation: The Cash Killer
While having cash in your hand seems like a great way to stem your losses, cash is no defense against inflation. You think your money is safe when it's in cash, but over time, its value erodes. (Coping With Inflation Risk explains how inflation is less dramatic than a crash, but can be more devastating to your portfolio.)
Opportunity Costs Add Up
Opportunity cost is the cost of an alternative that must be forgone in order to pursue a certain action. Put another way, opportunity cost refers to the benefits you could have received by taking an alternative action. In the case of cash, taking your money out of the stock market requires that you compare the growth of your cash portfolio, which will be negative over the long term as inflation erodes your purchasing power, against the potential gains in the stock market. Historically, the stock market has generally been the better bet.
Time Is Money
When you sell your stocks and put your money in cash, odds are that you will eventually reinvest in the stock market. The question then becomes, when you should make this move. Trying to choose the right times to get in and out of the stock market is referred to as market timing. If you were unable to successfully predict the market's peak and sell, it is highly unlikely that you'll be any better at predicting its bottom and buying in just before it rises. (This strategy is popular, but can few do it successfully, read Market Timing Fails As A Money Maker for tips.)
Common Sense Is King
Common sense may be the best argument against moving to cash, and selling your stocks after the market tanks means that you bought high and are selling low. That would be the exact opposite of a good investing strategy. While your instincts may be telling you to save what you have left, your instincts are in direct opposition with the most basic tenet of investing. The time to sell was back when your investments were in the black - not when you are deep in the red. (To learn more, read To Sell Or Not To Sell.)
Buy and Hold on Tight
You were happy to buy when the price was high because you expected it to go higher. Now that it is low, you expect it fall forever. Look at the markets over time. They have historically gone up. Companies are in business to make money. They have a vested interest in profitability. Investing in equities should be a long-term endeavor, and the long term favors those who stay invested. (My comment: Totally in agreement.) (For additional reading, check out Long-Term Investing: Hot Or Not?)
Nerve Wracking, but Necessary
Serious investors understand that the markets are no place for the faint of heart. Of course, with private pension plans disappearing and the future of Social Security in question, many of us have no other choice. (Be sure to read, The Demise Of The Defined-Benefit Plan, which provides a closer look at this situation.)
Once you've faced the facts, you need to have a plan.
by Lisa Smith, (Contact Author Biography)
by Lisa Smith (Contact Author Biography)
When stock markets become volatile, it makes investors nervous. In many cases, this prompts them to take money out of the market and keep it in cash. Cash can be seen, felt and spent at will and for most people, having money in hand feels safe. But how safe is it really? Read on to find out whether your money is safer in the market or under your mattress.
All Hail Cash?
There are definitely some benefits to holding cash. When the stock market is in free fall, holding cash helps you avoid further losses. Even if the stock market doesn't fall on a particular day, there is always the potential that it could have fallen. This possibility is known as systematic risk, and it can be completely avoided by holding cash.
Cash is also psychologically soothing. During troubled times, you can see and touch cash. Unlike the rapidly dwindling balance in your brokerage account, cash will still be in your pocket or in your bank account in the morning.
However, while moving to cash might feel good mentally and help you avoid short-term stock market volatility, it is unlikely to be a wise move over the long term.
A Loss In Not a Loss ...
When your money is in the stock market and the market is down, you may feel like you've lost money, but you really haven't. At this point, it's a paper loss. A turnaround in the market can put you right back to breakeven and maybe even put a profit in your pocket. If you sell your holdings and move to cash, you lock in your losses. They go from being paper losses to being real losses with no hope of recovery. While paper losses don't feel good, long-term investors accept that the stock market rises and falls. Maintaining your positions when the market is down is the only way that your portfolio will have a chance to benefit when the market rebounds. (For more insight, see How are realized profits different from unrealized, or so-called "paper", profits?)
Inflation: The Cash Killer
While having cash in your hand seems like a great way to stem your losses, cash is no defense against inflation. You think your money is safe when it's in cash, but over time, its value erodes. (Coping With Inflation Risk explains how inflation is less dramatic than a crash, but can be more devastating to your portfolio.)
Opportunity Costs Add Up
Opportunity cost is the cost of an alternative that must be forgone in order to pursue a certain action. Put another way, opportunity cost refers to the benefits you could have received by taking an alternative action. In the case of cash, taking your money out of the stock market requires that you compare the growth of your cash portfolio, which will be negative over the long term as inflation erodes your purchasing power, against the potential gains in the stock market. Historically, the stock market has generally been the better bet.
Time Is Money
When you sell your stocks and put your money in cash, odds are that you will eventually reinvest in the stock market. The question then becomes, when you should make this move. Trying to choose the right times to get in and out of the stock market is referred to as market timing. If you were unable to successfully predict the market's peak and sell, it is highly unlikely that you'll be any better at predicting its bottom and buying in just before it rises. (This strategy is popular, but can few do it successfully, read Market Timing Fails As A Money Maker for tips.)
Common Sense Is King
Common sense may be the best argument against moving to cash, and selling your stocks after the market tanks means that you bought high and are selling low. That would be the exact opposite of a good investing strategy. While your instincts may be telling you to save what you have left, your instincts are in direct opposition with the most basic tenet of investing. The time to sell was back when your investments were in the black - not when you are deep in the red. (To learn more, read To Sell Or Not To Sell.)
Buy and Hold on Tight
You were happy to buy when the price was high because you expected it to go higher. Now that it is low, you expect it fall forever. Look at the markets over time. They have historically gone up. Companies are in business to make money. They have a vested interest in profitability. Investing in equities should be a long-term endeavor, and the long term favors those who stay invested. (My comment: Totally in agreement.) (For additional reading, check out Long-Term Investing: Hot Or Not?)
Nerve Wracking, but Necessary
Serious investors understand that the markets are no place for the faint of heart. Of course, with private pension plans disappearing and the future of Social Security in question, many of us have no other choice. (Be sure to read, The Demise Of The Defined-Benefit Plan, which provides a closer look at this situation.)
Once you've faced the facts, you need to have a plan.
- Figure out how much money you need to amass to meet your future needs, and develop a plan to help your portfolio get there.
- Find an asset allocation strategy that meets your needs.
- Monitor your investments.
- Rebalance your portfolio to correspond with market conditions, making sure to maintain your desired mix of investments.
- When you reach your goal, move assets out of equities and into less volatile investments.
by Lisa Smith, (Contact Author Biography)
Wednesday 21 January 2009
Advice for Uncertain Times
Ben Stein How Not to Ruin Your Life
Advice for Uncertain Times
by Ben Stein
Posted on Tuesday, January 20, 2009, 12:00AM
The night before Dr. Martin Luther King, Jr., was assassinated in Memphis, he gave a memorable, inspiring speech. At its end, he said, "I don't know what's going to happen with me now. We've got some difficult days ahead...."
Unfortunately, this is true now about the American (and global) economy. I wish I could say I knew what was going to happen in the future. I have learned that I do not. I was not given the gift or the burden of foresight. I thought that our government would not let the bottom fall out. I was wrong. I am sorry.
So given that I do not know the future, what can I tell you that will be useful? Actually, quite a bit.
Cash Really Is King
First, taking the advice of my dear pal Ray Lucia, rock and roll star and investment guru, I can tell you that, no matter what happens, it will be good to have a nice chunk of money in cash or near cash. Yes, I know we may soon have inflation. But if we do, the rates on money market funds will rise. Cash is just a lovely thing to have in almost situation. Cash or near cash offers a level of comfort that even a large portfolio of stocks does not offer.
Taking a cue from my dear pal Phil DeMuth of Conservative Wealth Management, I can tell you that, if you think we are definitely at a bottom, you might be fooled. While Phil's research tells us that we may be near a bottom by postwar metrics of price, price to earnings, and price to dividends, we may have ( as Phil puts it ) "jumped the tracks of history."
My own view is that we have been fooled so much in the past 15 months about what real earnings are, what real book value is, that we cannot trust the data given to us. Yes, by current price-earnings measures, stocks look fairly reasonable. But we don't really know what true earnings are. That is the vicious truth. So if we are in the quicksand of not being able to rely on the data our companies give out, then anything can happen. Yes, we may be at a bottom or near it. Or we may not be anywhere near a bottom.
Anything Can Happen
Just to illustrate, who would have dreamed a few weeks ago that Citi would be in the kind of trouble it is in, even after a $45 BILLION infusion from the federal government? Anything can happen in the treacherous world in which we find ourselves.
Third, taking counsel from my pal Barron Thomas, very possibly the best salesman on the planet, I will tell you a rule of indisputable value in this or any economic situation: WORK.
Barron is in the real estate and private plane businesses. These are both highly impacted by the economic slowdown. How does Barron deal with it? He gets up at 5 a.m. every day and works the phones from 7 a.m. to 7 p.m., goes home, makes notes, and then sleeps well until he starts all over again. And he closes the deals. There are still plenty of people who will make the deal at the right price.
Keep on Working
Next, from yours truly: Work is deeply therapeutic. It makes us feel better. It gives us a much better attitude about ourselves. It makes us feel as if we are worth something. A middle class person who works has a far better self image than a rich person who does not work. Work is a gift, a sacrament, a true blessing. Plus, people who work are generally going to have higher incomes and higher standards of life than people who do not work.
If times are tough, work harder than ever. You will get through the rough patches and learn how strong you really are. Do not seek to avoid work -- embrace it.
Then, finally, I will tell you something I do when I feel buffeted by the markets. I dig into the 12-step program that has saved my life for the past 20 years. Using its precepts, I say to myself, "I am powerless over the stock market. It is all up to God. I do the very best I can, and after that, it's up to God."
Know What's Important
If you don't believe in God, then you can substitute "fate." Powerlessness is a huge source of power. Try it. You will like it.
"We shall overcome," we used to sing at civil rights demonstrations when we were getting tear gassed. "We are not afraid." Now I lie in bed at night and say to myself that if the men and women at military hospitals in this country and abroad can get through what they do, if their families can go through what they go through, then I can deal with market volatility -- trivial by comparison.
And so -- here it is. I do not know how it -- the stock market and economic turmoil -- will end, but to paraphrase The Bard, it will end, and that suffices.
http://finance.yahoo.com/expert/article/yourlife/135453
Advice for Uncertain Times
by Ben Stein
Posted on Tuesday, January 20, 2009, 12:00AM
The night before Dr. Martin Luther King, Jr., was assassinated in Memphis, he gave a memorable, inspiring speech. At its end, he said, "I don't know what's going to happen with me now. We've got some difficult days ahead...."
Unfortunately, this is true now about the American (and global) economy. I wish I could say I knew what was going to happen in the future. I have learned that I do not. I was not given the gift or the burden of foresight. I thought that our government would not let the bottom fall out. I was wrong. I am sorry.
So given that I do not know the future, what can I tell you that will be useful? Actually, quite a bit.
Cash Really Is King
First, taking the advice of my dear pal Ray Lucia, rock and roll star and investment guru, I can tell you that, no matter what happens, it will be good to have a nice chunk of money in cash or near cash. Yes, I know we may soon have inflation. But if we do, the rates on money market funds will rise. Cash is just a lovely thing to have in almost situation. Cash or near cash offers a level of comfort that even a large portfolio of stocks does not offer.
Taking a cue from my dear pal Phil DeMuth of Conservative Wealth Management, I can tell you that, if you think we are definitely at a bottom, you might be fooled. While Phil's research tells us that we may be near a bottom by postwar metrics of price, price to earnings, and price to dividends, we may have ( as Phil puts it ) "jumped the tracks of history."
My own view is that we have been fooled so much in the past 15 months about what real earnings are, what real book value is, that we cannot trust the data given to us. Yes, by current price-earnings measures, stocks look fairly reasonable. But we don't really know what true earnings are. That is the vicious truth. So if we are in the quicksand of not being able to rely on the data our companies give out, then anything can happen. Yes, we may be at a bottom or near it. Or we may not be anywhere near a bottom.
Anything Can Happen
Just to illustrate, who would have dreamed a few weeks ago that Citi would be in the kind of trouble it is in, even after a $45 BILLION infusion from the federal government? Anything can happen in the treacherous world in which we find ourselves.
Third, taking counsel from my pal Barron Thomas, very possibly the best salesman on the planet, I will tell you a rule of indisputable value in this or any economic situation: WORK.
Barron is in the real estate and private plane businesses. These are both highly impacted by the economic slowdown. How does Barron deal with it? He gets up at 5 a.m. every day and works the phones from 7 a.m. to 7 p.m., goes home, makes notes, and then sleeps well until he starts all over again. And he closes the deals. There are still plenty of people who will make the deal at the right price.
Keep on Working
Next, from yours truly: Work is deeply therapeutic. It makes us feel better. It gives us a much better attitude about ourselves. It makes us feel as if we are worth something. A middle class person who works has a far better self image than a rich person who does not work. Work is a gift, a sacrament, a true blessing. Plus, people who work are generally going to have higher incomes and higher standards of life than people who do not work.
If times are tough, work harder than ever. You will get through the rough patches and learn how strong you really are. Do not seek to avoid work -- embrace it.
Then, finally, I will tell you something I do when I feel buffeted by the markets. I dig into the 12-step program that has saved my life for the past 20 years. Using its precepts, I say to myself, "I am powerless over the stock market. It is all up to God. I do the very best I can, and after that, it's up to God."
Know What's Important
If you don't believe in God, then you can substitute "fate." Powerlessness is a huge source of power. Try it. You will like it.
"We shall overcome," we used to sing at civil rights demonstrations when we were getting tear gassed. "We are not afraid." Now I lie in bed at night and say to myself that if the men and women at military hospitals in this country and abroad can get through what they do, if their families can go through what they go through, then I can deal with market volatility -- trivial by comparison.
And so -- here it is. I do not know how it -- the stock market and economic turmoil -- will end, but to paraphrase The Bard, it will end, and that suffices.
http://finance.yahoo.com/expert/article/yourlife/135453
Sunday 14 December 2008
Cash Is Looking Better As Investment
INVESTING
OCTOBER 8, 2008, 4:18 P.M. ET
Cash Is Looking Better As Investment
As the market pushes investors beyond their comfort zones, cash and cash-equivalent investments -- traditionally stodgy options for advisors -- are gaining appeal.
By SUZANNE BARLYN
Cash and cash-equivalent investments - traditionally stodgy options for advisors - are gaining appeal as extreme market volatility pushes many clients beyond their comfort zones.
Advisors typically suggest that clients limit cash exposure to between 5% and 10% of their portfolios, or maintain a reserve that is equivalent to between 18 and 24 months of living expenses, in the event of a bear market. But some advisors are increasing their clients' cash holdings and exposure to other "cashlike" short-term investments, particularly to U.S. Treasurys, a safe haven in a brutal market.
"Cash is looking better for a few different reasons," says Donald B. Cummings Jr., an investment advisor with Blue Haven Capital in Geneva, Ill. Cummings says he was concerned that some municipal money-market funds would potentially "break the buck" - or fall below $1 per share. He preemptively moved client funds into plain-vanilla U.S. Treasury money-market funds. Cummings recognizes that Treasury yields are low. For example, the current seven-day yield for the Dreyfus 100% U.S. Treasury Money Market Fund (DUSXX) is 0.51%. However, the strategy is more tolerable for the short term, he says.
"People expect volatility, but no one wants to lose three and four percent on their money-market funds," says Cummings. He's not entirely sold on the Treasury Department's temporary guarantee program for money-market funds, he says, which protects certain shareholders of money-market mutual funds from losses if their funds are unable to maintain a $1 net asset value. The program offers protection for money-market holdings valued as of Sept. 19. Cummings says he's concerned about jeopardizing funds deposited after that time. "We're telling everyone to hold tight for a few months and see how this plays out," he says.
Advisors are also being judicious about investing new cash from clients since the bear market onset in October 2007. Cathy Curtis, a financial planner based on Oakland, Calif., says she's been particularly cautious with several new clients she took on last October, when the market started its decline, whose accounts average about $500,000. Curtis says she invested about 50% of their money at the time and left the rest in cash, including the Schwab Value Advantage Money Fund (SWBXX). "I have been investing it slowly - even over the last month," she says - about $2,500 at a time.
Cummings is stretching cash that he'd normally invest within about a month across a four- to five-month span. He stashes funds that he plans to invest at a later time in pre-refunded municipal bonds - a high-quality municipal bond in which the income and principal is typically insured by an irrevocable trust of U.S. securities. Cummings says that tax-free yields are between 1.5% to 2.5% - significantly better than U.S. Treasurys. A three-month T-bill, for example, currently yields 0.75%. "There are places to hide on the short end of the curve that make a lot of financial sense," he says.
Some advisors are also considering their clients' sense of well-being. "It's important that people feel safe and that they're going to have some liquidity," says Pran Tiku, a wealth manager for Peak Financial Management Inc. in Waltham, Mass. He's raising cash by selling off lower-quality, higher-yielding bonds, which are typically viewed unfavorably by bond-rating agencies. "If the credit crunch is as ominous as it seems and does not have a resolution, then cash becomes a very important investment to hold," he says.
Tiku has been investing the cash in short-term bonds, such as short-term Treasurys and government instruments, as well as money-market funds. A 5% minimum of clients' balanced portfolios is typically held in cash and cashlike investments. But Tiku has increased the allocation to about 30%. He's decreased bond allocations to 7% from about 30%.
For Doug DeGroote, managing director of United Wealth Management in Westlake Village, Calif., increasing his cash allocation serves another purpose. "We're sitting in a more liquid stance and looking for [buying] opportunities. It's being prepared for a chance to move money back into the market," he says.
DeGroote says he converted low-yielding short-term bonds to cash in preparation to snag good deals. DeGroote's firm typically allocates between 5% and 10% of client portfolios in cash, However, the figure is presently closer to 20%, he says.
Not all advisors are completely sold, however. Mark Colgan, president of Colgan Capital in Pittsford, N.Y., says he modifies his plan only after a client calls on three occasions and expresses extreme anxiety - indicating a client's lack of risk tolerance. If the client is a retiree, Colgan will then build a small cash position of between 12 and 24 months' worth of withdrawals to ride out the bear market. But he urges younger clients to stay the course. "For me, it is more about aligning the client with the proper portfolio - not reacting to the markets," he says.
Laura Mattia, an advisor with Baron Financial Group in Fair Lawn, N.J., says the firm adopts an "all-weather strategy" with clients early on and doesn't waver. Mattia and her colleagues typically limit cash exposure to 18 months of a client's personal expenses. "All of these assets will come back. They are going to rebound," she says. "The day when the stock market goes up 800 points is when people are going to be sitting there in cash saying I should have, would have could have."
Write to Suzanne Barlyn at suzanne.barlyn@wsj.com
http://online.wsj.com/article/SB122349648494716461.html
OCTOBER 8, 2008, 4:18 P.M. ET
Cash Is Looking Better As Investment
As the market pushes investors beyond their comfort zones, cash and cash-equivalent investments -- traditionally stodgy options for advisors -- are gaining appeal.
By SUZANNE BARLYN
Cash and cash-equivalent investments - traditionally stodgy options for advisors - are gaining appeal as extreme market volatility pushes many clients beyond their comfort zones.
Advisors typically suggest that clients limit cash exposure to between 5% and 10% of their portfolios, or maintain a reserve that is equivalent to between 18 and 24 months of living expenses, in the event of a bear market. But some advisors are increasing their clients' cash holdings and exposure to other "cashlike" short-term investments, particularly to U.S. Treasurys, a safe haven in a brutal market.
"Cash is looking better for a few different reasons," says Donald B. Cummings Jr., an investment advisor with Blue Haven Capital in Geneva, Ill. Cummings says he was concerned that some municipal money-market funds would potentially "break the buck" - or fall below $1 per share. He preemptively moved client funds into plain-vanilla U.S. Treasury money-market funds. Cummings recognizes that Treasury yields are low. For example, the current seven-day yield for the Dreyfus 100% U.S. Treasury Money Market Fund (DUSXX) is 0.51%. However, the strategy is more tolerable for the short term, he says.
"People expect volatility, but no one wants to lose three and four percent on their money-market funds," says Cummings. He's not entirely sold on the Treasury Department's temporary guarantee program for money-market funds, he says, which protects certain shareholders of money-market mutual funds from losses if their funds are unable to maintain a $1 net asset value. The program offers protection for money-market holdings valued as of Sept. 19. Cummings says he's concerned about jeopardizing funds deposited after that time. "We're telling everyone to hold tight for a few months and see how this plays out," he says.
Advisors are also being judicious about investing new cash from clients since the bear market onset in October 2007. Cathy Curtis, a financial planner based on Oakland, Calif., says she's been particularly cautious with several new clients she took on last October, when the market started its decline, whose accounts average about $500,000. Curtis says she invested about 50% of their money at the time and left the rest in cash, including the Schwab Value Advantage Money Fund (SWBXX). "I have been investing it slowly - even over the last month," she says - about $2,500 at a time.
Cummings is stretching cash that he'd normally invest within about a month across a four- to five-month span. He stashes funds that he plans to invest at a later time in pre-refunded municipal bonds - a high-quality municipal bond in which the income and principal is typically insured by an irrevocable trust of U.S. securities. Cummings says that tax-free yields are between 1.5% to 2.5% - significantly better than U.S. Treasurys. A three-month T-bill, for example, currently yields 0.75%. "There are places to hide on the short end of the curve that make a lot of financial sense," he says.
Some advisors are also considering their clients' sense of well-being. "It's important that people feel safe and that they're going to have some liquidity," says Pran Tiku, a wealth manager for Peak Financial Management Inc. in Waltham, Mass. He's raising cash by selling off lower-quality, higher-yielding bonds, which are typically viewed unfavorably by bond-rating agencies. "If the credit crunch is as ominous as it seems and does not have a resolution, then cash becomes a very important investment to hold," he says.
Tiku has been investing the cash in short-term bonds, such as short-term Treasurys and government instruments, as well as money-market funds. A 5% minimum of clients' balanced portfolios is typically held in cash and cashlike investments. But Tiku has increased the allocation to about 30%. He's decreased bond allocations to 7% from about 30%.
For Doug DeGroote, managing director of United Wealth Management in Westlake Village, Calif., increasing his cash allocation serves another purpose. "We're sitting in a more liquid stance and looking for [buying] opportunities. It's being prepared for a chance to move money back into the market," he says.
DeGroote says he converted low-yielding short-term bonds to cash in preparation to snag good deals. DeGroote's firm typically allocates between 5% and 10% of client portfolios in cash, However, the figure is presently closer to 20%, he says.
Not all advisors are completely sold, however. Mark Colgan, president of Colgan Capital in Pittsford, N.Y., says he modifies his plan only after a client calls on three occasions and expresses extreme anxiety - indicating a client's lack of risk tolerance. If the client is a retiree, Colgan will then build a small cash position of between 12 and 24 months' worth of withdrawals to ride out the bear market. But he urges younger clients to stay the course. "For me, it is more about aligning the client with the proper portfolio - not reacting to the markets," he says.
Laura Mattia, an advisor with Baron Financial Group in Fair Lawn, N.J., says the firm adopts an "all-weather strategy" with clients early on and doesn't waver. Mattia and her colleagues typically limit cash exposure to 18 months of a client's personal expenses. "All of these assets will come back. They are going to rebound," she says. "The day when the stock market goes up 800 points is when people are going to be sitting there in cash saying I should have, would have could have."
Write to Suzanne Barlyn at suzanne.barlyn@wsj.com
http://online.wsj.com/article/SB122349648494716461.html
Monday 1 December 2008
Is cash really king?
Buffett makes another prediction, but one that the world’s media did not pick up on. He said that “the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts”.
Buffett’s point is that the only way that the US – and other Anglo Saxon governments for that matter – is going to get itself out of its debt hole, is by inflating its way out.
In a best case scenario, this only entails sharply rising interest rates and substantial dollar depreciation.
In the worst case, a loss of confidence in banking systems and gold, assuming it is not outlawed, perhaps at $10,000 per ounce.
In both cases, holding cash would be a very bad idea.
In an inflationary environment, as Buffett says, it is best to hold stocks. Just make sure they are ones that will survive.
-----
Is cash really king?
By Hugh Young
19 November 2008
Holding cash in an inflationary environment is a very bad idea.
On October 17 Warren Buffett wrote in The New York Times that “equities will almost certainly outperform cash over the next decade, probably to a substantial degree”. Amid all the confusion, such a clear and bold prediction is jolting. Cash is king, right? How can Buffett be so sure that equities will mount a royal coup?
Buffett makes another prediction, but one that the world’s media did not pick up on. He said that “the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts”.
What! Inflation? Wasn’t that yesterday’s story? Oil prices have halved, as have the prices of many other commodities. And anyway, commodity prices never stayed high enough to trigger wage spirals. All they did was cause demand to fall.
Buffett’s point is that the printing presses have been turned on, following years of reckless monetary expansion, and that all the hundreds of billions of extra dollars recently created to prop up the banking system will ultimately feed through to rising prices (remember that inflation is really about money supply. Rising prices are the effect of inflation, not inflation itself).
Taking into account unfunded social security and Medicare obligations, the total US federal debt in 2006 was $49.4 trillion, equivalent to $160,000 for every American. Fast forward two years, during which there was an acceleration of government debt accumulation, and you get close to $300,000 for every working American. If Americans were to set aside, say, 3% of their average annual household income of around $48,000, it would take more than 200 years to pay off the debt.
The conjuring trick here required to create this debt mountain has been to convince people, Americans and foreigners alike, that the dollar, dollar deposits and federal debt are worth something. Spin is provided by implicit government guarantees, and continual reference to the dollar as the world’s de facto reserve currency. As long as there was confidence in the currency, debt (relative to economic activity) could rise forever.
We take for granted that bits of paper (bank notes) and electronic records in computer chips (bank deposits) have “value” to such an extent that it is impossible to imagine it any other way or, worse, the entire system collapsing. Article one, section 10, of the United States Constitution states that “no state shall…coin money; emit bills of credit; make any Thing but gold and silver Coin a Tender in Payment of Debts”.
Why were the founding fathers so against paper money (fiat currency)? Because they were aware that, throughout history, every single state-controlled fiat currency system had ultimately failed. The temptations to create money out of nothing could never be resisted, leading to the corruption of politicians and the elite and unsustainable wealth disparity between rich and poor.
George Washington had noted in 1787 that “paper money has had the effect to ruin commerce, oppress the honest, and open the door to every species of fraud and injustice”. Later, in 1798, Thomas Jefferson wrote that the federal government has no power “of making paper money or anything else a legal tender”, and he advocated a constitutional amendment to enforce this principle by denying the federal government the power to borrow.
In days gone by money or, as it is also known, “IOUs”, developed naturally in the market. The best medium for these IOUs was gold coins as they were difficult to fake (gold is heavy, sufficiently scarce, expensive to extract and impossible to synthesise below its market value). But governments soon took control, often by guaranteeing the quality and purity of the coins. As governments outspent their revenues, they found ways to counterfeit the currency by reducing the amount of gold in the coins, hoping their subjects would not discover the fraud. But the people always did, and they tended to react badly.
What is happening today is no different. For money to be considered legal tender it must have a maker (person that will make the payment), a payee (person that will receive the payment), an amount to be paid, and a due date. Dollar bills used to state that the bearer would be paid on demand. In 1963 these words were removed.
By the same token the creation of bank deposits involves even less work than notes and coins, which at least require machines with moving parts. To create bank deposits, a bank simply needs to find someone to lend to, then punches a number into a computer. Boosh! A bank deposit! Even if the borrower spends the money such that it ends up in another bank, it’s still in the system.
When President Nixon closed the gold window in 1971, refusing, as promised under the Bretton Woods Agreement, to exchange dollars for one thirty fifth of an ounce of gold (there was not enough gold in the coffers), the stage was set for massive and unconstrained monetary expansion. Under Bretton Woods, credit as a percentage of GDP had been maintained at around 150%. From 1980 to 2007, it rose from 162% to 334%. The last 30 years have been one huge, credit-fuelled party. But the booze has now run out and the hangovers are just beginning.
Buffett’s point is that the only way that the US – and other Anglo Saxon governments for that matter – is going to get itself out of its debt hole, is by inflating its way out. In a best case scenario, this only entails sharply rising interest rates and substantial dollar depreciation. In the worst case, a loss of confidence in banking systems and gold, assuming it is not outlawed, perhaps at $10,000 per ounce. In both cases, holding cash would be a very bad idea. In an inflationary environment, as Buffett says, it is best to hold stocks. Just make sure they are ones that will survive.
Hugh Young is the Singapore-based managing director of Aberdeen Asset Management Asia.
© Haymarket Media Limited. All rights reserved.
http://www.asianinvestor.net/article.aspx?CIaNID=89287
Buffett’s point is that the only way that the US – and other Anglo Saxon governments for that matter – is going to get itself out of its debt hole, is by inflating its way out.
In a best case scenario, this only entails sharply rising interest rates and substantial dollar depreciation.
In the worst case, a loss of confidence in banking systems and gold, assuming it is not outlawed, perhaps at $10,000 per ounce.
In both cases, holding cash would be a very bad idea.
In an inflationary environment, as Buffett says, it is best to hold stocks. Just make sure they are ones that will survive.
-----
Is cash really king?
By Hugh Young
19 November 2008
Holding cash in an inflationary environment is a very bad idea.
On October 17 Warren Buffett wrote in The New York Times that “equities will almost certainly outperform cash over the next decade, probably to a substantial degree”. Amid all the confusion, such a clear and bold prediction is jolting. Cash is king, right? How can Buffett be so sure that equities will mount a royal coup?
Buffett makes another prediction, but one that the world’s media did not pick up on. He said that “the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts”.
What! Inflation? Wasn’t that yesterday’s story? Oil prices have halved, as have the prices of many other commodities. And anyway, commodity prices never stayed high enough to trigger wage spirals. All they did was cause demand to fall.
Buffett’s point is that the printing presses have been turned on, following years of reckless monetary expansion, and that all the hundreds of billions of extra dollars recently created to prop up the banking system will ultimately feed through to rising prices (remember that inflation is really about money supply. Rising prices are the effect of inflation, not inflation itself).
Taking into account unfunded social security and Medicare obligations, the total US federal debt in 2006 was $49.4 trillion, equivalent to $160,000 for every American. Fast forward two years, during which there was an acceleration of government debt accumulation, and you get close to $300,000 for every working American. If Americans were to set aside, say, 3% of their average annual household income of around $48,000, it would take more than 200 years to pay off the debt.
The conjuring trick here required to create this debt mountain has been to convince people, Americans and foreigners alike, that the dollar, dollar deposits and federal debt are worth something. Spin is provided by implicit government guarantees, and continual reference to the dollar as the world’s de facto reserve currency. As long as there was confidence in the currency, debt (relative to economic activity) could rise forever.
We take for granted that bits of paper (bank notes) and electronic records in computer chips (bank deposits) have “value” to such an extent that it is impossible to imagine it any other way or, worse, the entire system collapsing. Article one, section 10, of the United States Constitution states that “no state shall…coin money; emit bills of credit; make any Thing but gold and silver Coin a Tender in Payment of Debts”.
Why were the founding fathers so against paper money (fiat currency)? Because they were aware that, throughout history, every single state-controlled fiat currency system had ultimately failed. The temptations to create money out of nothing could never be resisted, leading to the corruption of politicians and the elite and unsustainable wealth disparity between rich and poor.
George Washington had noted in 1787 that “paper money has had the effect to ruin commerce, oppress the honest, and open the door to every species of fraud and injustice”. Later, in 1798, Thomas Jefferson wrote that the federal government has no power “of making paper money or anything else a legal tender”, and he advocated a constitutional amendment to enforce this principle by denying the federal government the power to borrow.
In days gone by money or, as it is also known, “IOUs”, developed naturally in the market. The best medium for these IOUs was gold coins as they were difficult to fake (gold is heavy, sufficiently scarce, expensive to extract and impossible to synthesise below its market value). But governments soon took control, often by guaranteeing the quality and purity of the coins. As governments outspent their revenues, they found ways to counterfeit the currency by reducing the amount of gold in the coins, hoping their subjects would not discover the fraud. But the people always did, and they tended to react badly.
What is happening today is no different. For money to be considered legal tender it must have a maker (person that will make the payment), a payee (person that will receive the payment), an amount to be paid, and a due date. Dollar bills used to state that the bearer would be paid on demand. In 1963 these words were removed.
By the same token the creation of bank deposits involves even less work than notes and coins, which at least require machines with moving parts. To create bank deposits, a bank simply needs to find someone to lend to, then punches a number into a computer. Boosh! A bank deposit! Even if the borrower spends the money such that it ends up in another bank, it’s still in the system.
When President Nixon closed the gold window in 1971, refusing, as promised under the Bretton Woods Agreement, to exchange dollars for one thirty fifth of an ounce of gold (there was not enough gold in the coffers), the stage was set for massive and unconstrained monetary expansion. Under Bretton Woods, credit as a percentage of GDP had been maintained at around 150%. From 1980 to 2007, it rose from 162% to 334%. The last 30 years have been one huge, credit-fuelled party. But the booze has now run out and the hangovers are just beginning.
Buffett’s point is that the only way that the US – and other Anglo Saxon governments for that matter – is going to get itself out of its debt hole, is by inflating its way out. In a best case scenario, this only entails sharply rising interest rates and substantial dollar depreciation. In the worst case, a loss of confidence in banking systems and gold, assuming it is not outlawed, perhaps at $10,000 per ounce. In both cases, holding cash would be a very bad idea. In an inflationary environment, as Buffett says, it is best to hold stocks. Just make sure they are ones that will survive.
Hugh Young is the Singapore-based managing director of Aberdeen Asset Management Asia.
© Haymarket Media Limited. All rights reserved.
http://www.asianinvestor.net/article.aspx?CIaNID=89287
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