Over the last 7 years, the stock market has witnessed a euphoric rise. Every £ put into the market has gone on to grow bigger than what is was before whilst cash on the other hand has remained stagnant or even lost value due to low interest rates and inflation. This has led investors to throw any fresh cash into the market as soon as they receive it as the opportunity cost of sitting on cash was too great. Cash has been the underachieving disliked asset class over this 7 year bull run but it is making a comeback. This could be the beginning of a shift in the overall character of a market that has trained many to buy each every dip over the past few years
Holding a chunk of your portfolio in cash during current market conditions is considered a must. Over the past year, cash has been in a bull market as seen by the image below.
A bull market for cash means that you are now able to buy assets for cheaper than you could have a year ago. This makes holding cash very attractive at the moment. Looking at Equities in particular, cash has increased in value by over 10% relative to this asset class. This means that you are now abel to buy more stocks or a higher ownership stake in a particle business with the same amount of money than you could have 12 month ago.
Now I am not saying stay out of stocks, what I am saying is that you should not invest all fresh cash in stocks but rather keep some in cash. Most people whom have £1,000 to invest every month have been throwing this in to the market over the past 7 years. But now, as times are changing, it would be more wise to keep a buffer of cash – put £600 in the market and keep £400 as cash. (The longer the bull market for cash runs, the higher the proportion of fresh monies you should leave in cash.)
By having cash in your accounts, you will be able to buy into stocks at great prices were a correction happen to occur. Just look what happened this past January, many blue chip stocks were on sale at one point or the other. Whilst most people did realise that these companies were trading at fantastic valuations and getting in at these prices would increase their wealth substantially in the long term, they could do absolute nothing about it! They did not have cash on hand. They have had to wait until the end of the month month when their pay check comes in and at this point, the prices have risen already. They were not able to buy into great opportunities.
On the other hand, if you kept a portion of your portfolio in cash, you were easily able to gobble of these stocks as you had the required cash on hand. You would have been able to buy stocks at lower price points thus compounding your money at higher rates over the long term. If you saved £400 from last April when markets were overvalued by both the CAPE Ratio and Buffet Index, you would have had £3600. By putting this all in Royal Dutch Shell (RDSB) stock which was yielding 10% in Mid January, you could have got £360 sent to you from Shell every year just for being patient. (For simplicity, i have ignored any amounts you would have put in the market during the late August correction).
Being patient pays off. Most people want to reach Financial Independence as as soon as possible and by being patient, you can accelerate the process as you can get stocks at your price thereby increasing your margin of safety and dividend yield. By being patient and accumulating your cash reserves you can strike when the opportunity present itself. As Benjamin Graham has observed, an investor who is serious about money management and who is patient enough will usually get their price. Sometimes this happens suddenly without warning, like the crash in October of 1987, other times, it’s the result of a long, cold neglect, but the odds are okay that you’ll be able to get your hands on ownership at an outlay you consider reasonable. By having cash on hand, you would be able to get the price you want.
The point is, just because you have received some cash doesn’t necessarily mean you should throw it into the market straight away. Look at valuations and see if it makes sense. This is particularly true for index investors as certain indexes like the S&P500 are richly valued due to grossly overvalued companies like Amazon, Google, Netflix and Facebook. If you mindlessly reinvest dividends or dollar cost average your way into an index fund you would end up paying top dollar for the inflated future income stream from these investments.
It is in these times that people who invest in individual stocks have an advantage. There is always value to be found in individual stocks. But many wonderful companies are still richly valued and I for one will be keeping 40% of any new investable amounts in cash.