A little extra cash is not a bad thing

I must admit, I used the recent stock market rally to sell some of my clients’ and my holdings, and I didn’t re-invest the money into something else right away.

This may sound like a prudent thing to do, but many take issue with such an approach.

They believe not being fully invested means timing the market. But I disagree with the approach that always being fully invested is the smartest way to go. I also disagree that not being fully invested–holding cash–means timing the market.

In the history of free enterprise, the most successful businesses almost always operate more conservatively than they need to. By doing so, they have the ability to be aggressive in difficult times.

During the Great Depression, companies with extra cash were able to boost advertising at low rates, purchase competitors at cheap prices, expand into new markets, etc., while their competitors were simply attempting to survive the crisis. Having extra cash on hand during tough times allows great businesses to buy at super-cheap prices exactly when competitors are hamstrung.

The same is true for investing. By operating a bit more conservatively–holding extra cash in principle–an investor can purchase during those rare times when prices are once-in-a-lifetime cheap. Those who are fully invested cannot. Those with extra cash may under-perform during boom times, but they tend to out-perform over the long run.

Holding extra cash is not the same as timing the market, either.

Timing the market is the attempt to sell at the top and buy at the bottom. That’s not my approach, nor do I think timing the market is a successful strategy.

Instead, I assess the value of businesses. With such an assessment, I attempt to purchase businesses (that’s what buying stock is: purchasing part-ownership in businesses) when they are cheap and sell them when they’re dear. The buying and selling occurs because of the relationship of price to value, not because of my opinion about the market’s top or bottom.

Carrying extra cash can be a competitive advantage, both in business and investing. I’m happy to sit on a little extra cash and wait for stock prices to move to cheaper valuations. If it happens sooner, great. If later, that’ll work, too.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

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The investing world’s Holy Grail

Archimedes once said that he could move the world with a large enough lever and a place to stand. Like Archimedes, I think I could “move the world” by dramatically improving investors’ returns–if I could just eliminate their desire to time the market.

I don’t believe there is anything that destroys long term investment returns as much as the desire to time the market. It is the investing world’s Holy Grail–it doesn’t exist, but people keep trying to find it anyway.

Every investor seems to wish he could sell at “the top” and buy at “the bottom.” Very few consider whether this feat is possible with anything other than hindsight. If investors would consider this seriously, perhaps their returns would improve dramatically.

The stories investors hear about someone who supposedly sold at “the top” and bought back at “the bottom” seems to egg them on. Like feats of ESP, this supposed achievement is frequently sited but infrequently submitted to rigorous study.

Remember, even a broken clock is right twice a day. So, if someone repeats over and over again that the market is going to drop, at some point they will be right. Same with the market rallying. This is not a demonstration of skill, but that a broken clock can be right.

Have you ever examined the Forbes 400 list of richest people? Check it out some time, and look for the market timers. You won’t find a single one. In fact, the guy topping the list, Warren Buffett, says timing the market is not possible. Take his advice, seek not the Holy Grail.

The investors who build wealth over the long run do it by PRICING, not TIMING. They figure out something is cheap and they buy it. They don’t panic when it becomes cheaper, because they know what it’s worth. They usually buy more.

Those who try to time the market end up guessing about market tops and bottoms, because such things can only be seen clearly in hindsight. They almost always end up buying high and selling low.

Look at the statistics on investor versus mutual fund returns. Mutual fund returns are anywhere from 4% to 8% higher than the returns investors get. Why? Because most investors, in their search for the Holy Grail, sell what’s not “working” and buy what is “working.” They almost always sell something that is about to take off and buy something that’s about to tank.

I’m not saying people don’t get lucky every once in a while and sell at the top or buy at the bottom. What I’m saying is such luck should be associated with winning the lottery or getting struck by lightning, not with a sound approach to reaching your financial goals.

Don’t seek the Holy Grail. Buy when things are cheap and accept that they will almost certainly get cheaper. Buy more if it gets cheaper. Rinse and repeat. In 5 to 10 years, you’ll be very happy you didn’t pursue the investing world’s Holy Grail.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.