SubscribeMon 27 Aug 2007
This is not a post about why anyone should be running from the equity (or debt) markets. I’m firm a believer that most individuals should be as close to fully invested in the markets at all times. Market timing is awfully hard to accomplish. Nor do I believe that anyone needs more than 3 months in emergency fund assuming there are other sources to be tapped like equity lines of credit, maturing CDs, etc. Yet contrary to all those beliefs above, I believe many individuals would greatly benefit from having a cash stash.
There’s nothing else like cash. Not just cold hard cash in the form of bills and coins, but cash in a savings accounts, money market funds, checking accounts - basically what is defined as the M2 money supply less CDs. Unlike other investments which can be both illiquid and are generally invested with a time frame in mind, cash is definitionally liquid, and has no time constraints upon it.
However, the virtue of holding cash is not just having cash itself, but the opportunities that having cash begets. How many times have any of us said, “If I only had the money, I would’ve made fortune in X.’ X might be great real estate purchase. X could be an incredible stock idea. X could have been put into helping a friend start up a business. I don’t believe in get rich quick schemes, but I also believe that many successful individuals take calculated risk with the right business opportunities. In order to take those financial risk you either need to have the cash or borrow it. Unlike corporations, individuals cannot easily go out into the debt market and borrow money. The best option we have is to borrow via home equity. Personal loans generally have onerous terms that make them unpalatable for the purpose taking risks. Even if I did have good access to funds via a home equity line, I would not want to be 100% leveraged in a risk taking venture. I would be more comfortable putting cash to work and then using some leverage.
The question is how much cash is appropriate? Warren Buffet holds over 50 billion in cash at Berkshire Hathaway for potential investments. This is nearly 1/4 of the company’s market capitalization. 25 percent would be very large percentage of someones’ networth to be held in cash. I believe for most people the percentage held in cash should be much lower, and generally slides up as someones’ networth increases. Cash in some ways is the investment you make after you’ve made all your other investments. I can’t imagine most people would want to target more than 25% in cash holdings, but many people would be well served by being 10-20% cash. However, the most important part of being in cash is understanding that you are the type of person who wants and plans on taking risk with that cash.
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August 27th, 2007 at 10:28 am
Excellent post! This is something that I’ve never really considered before, thanks for the insight.
August 27th, 2007 at 1:01 pm
Agreed, using liquid wealth is always a firm standby.
August 28th, 2007 at 6:04 am
I’m still working on getting an emergency fund!
What type of ventures do you picture going into with your cash?
August 28th, 2007 at 8:46 am
SavingDiva, part of the reason to hold cash is to invest in opportunties as they arise - this money that’s not planned for anything in particular. However that said, I’m looking at real estate mostly. I think the housing downturn will create opportunties in the next couple years.
Also, a couple a years ago, one of my friends came to me with an investment opportunity to help him start a business. The captial was relatively low, but I didn’t have anything liquid, and passed on the in the investment. I regret it both financially, and also because I would’ve liked to help him to start his business. I used to work with him, and knew he was more than capable of finding success, not did I have delusions of control or risk as can often mar investing in friends and family. Next time around, I want to make such an investment.
September 3rd, 2007 at 6:36 pm
[...] AskDong explains why, despite all you may have heard to the contrary, cash is king. [...]
September 12th, 2007 at 7:03 pm
I’ve been lucky enough, and have worked hard enough, to save approximately 1 year’s worth of living expenses. For me, having a big cash cushion has been a huge psychic benefit. To Dong’s point, I feel well positioned to take advantage of opportunities as they come. That could be an investing opportunity or a personal one (e.g., being able to attend the destination wedding of a good friend). I expected those benefits from holding cash. What I didn’t expect is that I feel SO much less stressed at work because I know that to lose my job wouldn’t be apocalyptic. Keeping more cash on hand than I really need is more than worth it because I feel more secure and relaxed at work.