Being business owners, most of our clients hold more cash than the average person. The cash often acts as ballast for the heavy concentration (and potential risk) in a single asset – the business. The primary purpose of the cash is not to earn a rate of return (if it does, all the better). The primary purpose of the cash is to have liquidity ready and available should something go wrong with the business, or in the event a great opportunity becomes available for the business.
We have no issue with this strategy, even amidst today’s financial repression. We want our families and their businesses to be resilient and to be able to take advantage of opportunities (which often come when others are scrambling to service debt and sell assets). There’s a cost to that (in the form of losing a few percentage points to inflation each year) but it’s a cost we can live with given the benefit of resilience when viewed over multiple business cycles.
Separately, we currently suggest that clients hold some cash in their traditional investment portfolios. But why? If one is concerned about inflation in the near/medium-term (and we are) and if one is concerned about the value of money declining substantially in the longer-term (and we are), why hold an eroding asset like cash?
The principles we lean on (resilience and future opportunity) to answer those questions are similar to those discussed above in the context of business ownership. And with U.S. stock indexes at nosebleed levels and no shortage of speculative behavior, we think those principals are more than appropriate today.
But more specifically…first, the goal for a long-term investment portfolio is to protect and grow purchasing power at the portfolio level. We don’t necessarily need every component of the portfolio to win against inflation/debasement, we just need enough of the portfolio to win in order to ensure we don’t suffer an aggregate loss of purchasing power.
And if we can do that – and here’s my second point – it allows for cash in the portfolio to act as an option on future bargains. Crises are inevitable and cash gives us the ability to take advantage rather than running scared.
Third, cash has not fared as badly in past inflationary periods as one might think, and cash can benefit from rising yields if interest rates follow inflation higher (not true for long-term bonds).
Having said that, we do not expect interest rates to necessarily follow inflation higher in this cycle. We also want to be wary of having a lot of cash in the portfolio for long periods of time (e.g., a decade).We’re paying close attention to those considerations as we think about what lies ahead over the next 5-10 years.
Cash still has value, even if it’s not obvious today.