The Flinchum File
Thoughtful Economic Analysis and Existential Opinions

Enough Cash?

02/17/2016

The novice investor tries to buy a stock when it hits a low and sells it when it hits a high.  What could be wrong with that?  After all, doesn’t everybody say “buy low and sell high?”

As wonderful as that sounds, numerous studies have shown that “market timing” seldom works in the short-term term and never works in the long-term.  As Warren Buffett has told us repeatedly – buy stocks you like and hold them as long as you like them, preferably forever.

So, why do investment managers sometimes increase their level of cash?  Is it to have “dry powder” for when stocks get really low?  Isn’t this inconsistent with Buffett’s advice.  Yes, it is inconsistent with that advice, but Buffett’s advice refers to normal market volatility related to the business cycle, i.e., to a normal recession . . . not a financial crisis.

The level of cash should reflect some expectation about a financial crisis.  If you think a normal recession is approaching, you might shift more into consumer staple stocks but otherwise remain largely invested.  If you think a financial crisis is approaching, you might sell banking and other credit-sensitive stocks but hold the cash without reinvestment.  That’s the science of it.  How much cash you hold . . . well, that is the art of it.

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