Cash holdings

Buffett: "Cash, though, is to a business as oxygen is to an individual: never thought about when it is present, the only thing in mind when it is absent. When bills come due, only cash is legal tender. Don't leave home without it."

Some thoughts on cash holdings (cash allocation / cash policy)

Benefit of Cash:

- Cash is an emotional stabiliser. In bad/stressful times, having cash can help with calmer, more rational decisions.

- Cash gives options and flexibility.
- Cash has no volatility (from a non-FX angle)  

Negative in holding cash:

- Cash is like a dead weight, it drags down performance in good times

- Cash is forever eroding slowly due to inflation.  A slow death by a thousand cut.  Time is not your friend there.

- Cash is subject to exchange rate risk

So what's my policy in holding cash?

- mid market cycle - 75%

- high valuation cycle - 50% (sell high)

- low market valuation cycle - 95% (buy low)

Fully invested vs having a cash holding policy.  The sequence of events in a bull bear market makes no difference to P&L if money is not taken out of the system.  But if money is added (reinvested) and withdrew from time to time, then the order of event matters.  Hence having an implicit and disciplined buy low sell high strategy (which is what this cash policy is all about) helps.

Another way to look at appropriate cash allocation is the opportunity universe.  When opportunity is abundant (usually when market is depressed), then go fully invested (95%).  When opportunity is hard to come by (market is likely to be inflated), then reduce gradually to 50%.  

So:

Cash Holdings = 1/F(# available opportunities)

Cash Holdings = 1/F(valuation)

I should not and am not trying to time the market. If i leave the cash holding level as a function of available opportunities, and i always judge that on an absolute basis rather than a relative basis, this plan should work in the long run. A 50% floor is due to the fact that bubble or high valuation can sustain for longer than one can imagine.  US market rallied since 2009 for 8 years now.  I exited US completely in 2015, 2 years too early (still counting).  However, I will always get to the 95% too early in a depressed market and get to 50% too early in an inflated market, but that should still have a positive effect vs not having a cash policy.

Sit out and watching other people make money is one of the most corrosive feelings.  But keeping cash when you don't find opportunity is the precursor for having the cash when opportunities become available again.