Unconventional wisdom: Three underappreciated benefits of cash
Morgan Housel’s new book has got me thinking.
Conventional wisdom is a byproduct of groupthink that presents solutions good enough for the average person while simultaneously not being right for any individual. You follow it at your peril. Each Monday I will challenge the investing norms that just may be holding you back from living the life you want.
Unconventional wisdom: Three underappreciated benefits of cash
“I take time to go for long walks on the beach so that I can listen to what is going on inside my head. If my work isn’t going well, I lie down in the middle of a workday and gaze at the ceiling while I listen and visualise what goes on in my imagination.”
- Albert Einstein
I’ve recently been on leave and one of the books I read was Same as Ever by Morgan Housel. In-between my less productive vacation activities it got me thinking about two related topics – one philosophical and one practical.
On the philosophical side Housel writes that people in creative fields suffer by adhering to our societal norms about work and productivity. His definition of creative work is expansive and includes anyone who is not engaged in rote tasks.
Successful people tend to believe that as many hours as possible need to be spent ‘doing things.’ Don’t believe me? Look at the typical 7-year-olds’ schedule to see how we are passing this attitude onto the next generation.
I think investing is a creative field. All investors would benefit from spending more time thinking. Professional and individual investors spend too much time doing.
You can’t think and do at the same time. So take a walk, go on vacation or have a drink alone in a bar. Activities deemed as unproductive are more important than you think.
Investing is not portrayed as a creative activity. It is couched in a false sense of mathematical precision. That is nonsense.
Investing is not just about building discounted cash flow models and constant activity. It is about thinking about the challenges faced by companies trying to grow in a competitive world. It is about thinking about your goals and the best way to achieve them.
Housel uses both the opening Einstein quote and one from Mozart:
“When I am traveling in a carriage or walking after a good meal or during the night when I can’t sleep – it is on such occasions that my ideas flow best and most abundantly.”
Give yourself some space to allow ideas to gestate and creativity flourish. Both are critical to being a successful investor.
The productivity of cash
Housel’s view about the benefits of taking a walk can’t be measured in any quantitative sense. That makes touting the benefits of a walk heresy in the world view of management guru Peter Drucker.
Drucker was the one that said, ‘if you can’t measure it, you can’t manage it’. In Drucker’s view unless there is data that demonstrates the value of an activity it isn’t worth doing.
Drucker likely wouldn’t think highly of holding cash. Housel is a fan.
From a productivity standpoint holding cash is leaving your desk and taking a long walk during the workday.
Cash has the lowest long-term returns of any asset class. The more you allocate to cash the lower your long-term returns. Investing the cash would be more beneficial – in theory.
What is quantifiable doesn’t tell the whole story. I’m in Housel’s camp. I think the value of cash exceeds what we can measure.
Below are three underappreciated benefits of cash.
The value of cash increases as you age
I am sympathetic to people who heap scorn on cash because it reduces long-term returns. This used to be my attitude.
When I was young my emergency fund was small so I could get every dollar possible into the share market. I’m glad I did.
For younger investors time is the most valuable resource. The difference between the returns on cash and growth assets like shares matter more. The opportunity cost for holding cash is greater.
As you age the opportunity cost decreases. A simple example is illustrative. According to Vanguard over the past 30 years the real – or inflation adjusted - return on Aussie shares was 6.70% a year. For cash it was 1.50%.
Over a 40-year period a $10,000 investment in Aussie shares would grow to $133,837 in spending power. Cash would only grow to $18,140.
Over 10 years the spending power of an investment in Aussie shares would be $19,126 while cash would grow to $11,605.
Over 40 years your purchasing power would be 637% higher by investing in shares. Over 10 years it would be 64% higher. This is the power of compounding.
It speaks to the larger truth that as you age the downside of holding cash decreases. This leaves more room for the benefits of cash to win out.
Cash as peace of mind
It is very difficult to obtain peace of mind. This is obvious from the definition: ‘a state in which your brain is calm, at ease, and untroubled by worry.’ Everybody worries about something.
My own experience is typical. As my net worth and salary have increased it has not alleviated me of financial worries. Yet to compare my financial worries with someone struggling to put food on the table would show a pathological lack of empathy. I can still be worried about things while admitting that life is pretty good.
Peace of mind is not a binary state – you don’t go to bed not having peace of mind and wake up with it. It is a scale. And cash provides peace of mind in a way other assets don’t.
I consider myself a confident investor. But in the back of my mind there is a little voice whispering that the 1929 crash and Great Depression could be right around the corner. Perhaps you hear this voice as well.
The key is balance. When that voice gets too loud people end up with their entire net worth in a shoe box under their bed. When it is completely ignored people borrow money to buy one day options.
Spend some time thinking about the right balance for you between peace of mind and higher returns. Revisit your decision as it will likely change at different stages of your life.
Dry powder
I can’t be the only one that has this investing fantasy. The market is in free fall and people are panicking. The proverbial blood is in the streets. Capitulation.
But there I am - calm, cool and collected. Immune to the panic of the herd. Like a poker player I go all in and push my chips to the centre of the table.
I catch the market bottom. It rebounds sharply. My investing acumen is proclaimed far and wide. But I’m not around to hear this praise. I am sipping a Mai Tai by a pool in Bangkok.
This is a fantasy. It is not real life. I benefited from the global financial crisis (“GFC”). But only because I kept investing with each pay cheque during the long bear market.
I bought on the way down. I bought on the way up. I benefited from the GFC because I kept buying. But also because I was relatively young when it happened.
This is a familiar pattern. When you are young each new contribution is relatively large compared to your small portfolio. As your portfolio grows contributions are proportionally smaller. As you age your savings matter less and your returns matter more.
I am comfortable holding more cash at my age because I’m on track to achieve my goals, the opportunity cost is lower, and extra dry powder comes in handy to take advantage of opportunities.
Taking advantage of opportunities won’t resemble the fantasy scenario I outlined earlier. It will be supplementing the savings from my pay cheque by drawing down on my cash.
I won’t go all in. I won’t catch the bottom except by dumb luck. I will simply try and take advantage of any attractive opportunities that may present themselves.
A note of caution. Increasing your cash savings as you age is very different than selling assets and raising cash based on market conditions. That is market timing and investors are notoriously bad at it.
Final thoughts
In response to a recent podcast on a share I own a listener left a comment that I should quit “waffling”.
There is no waffling in my portfolio. I bought that share and I continue to hold it. What the listener didn’t like was me explaining why the share might be right for me and not right for other people. The listener didn’t like that I talked about why I might be wrong.
We all crave certainty. Rules that we can follow to achieve certain outcomes. Drink eight glasses of water a day and live forever. Walk 10,000 steps and have a movie star body. That isn’t how life works. And it isn’t how investing works.
There is no single pathway that all of us can follow. No way to guarantee the results we desire.
To be successful is partially about gaining knowledge. That is a necessary foundation. But it is also about understanding what you truly want out of life and spending time thinking about the best way to achieve that.
How do you know when you are on the right path? When you grasp why an investment, or holding a certain level of cash, might be right for some people and not right for you.
The best advice I can give any investor is to spend more time thinking than doing. Actions get us in trouble. A little thinking never hurt anyone.
Share your thoughts with me at mark.lamonica1@morningstar.com
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What i’ve been eating
I finished my recent to trip to the US with a stay in Miami. I did what I always do in Miami and mostly confined myself to South Beach. But I always make it a point to head to Calle Ocho. That is the Cuban neighbourhood far from the glitzy beaches.
No trip to Calle Ocho is complete without a stop at Versailles. You prounce the name of this temple of Cuban cuisine as ver-sales. This is not Louis XIV’s palace. Versailles is huge. The décor is garish. The waitstaff indifferent. But the food is cheap and it is delicious.
Pictured is a sampler dish. The stand-out is ropa vieja or beef stewed in sofrito. We added a Cuban sandwich – no explanation needed there. Plus Cuban style black beans which generally inspires me to repeatedly try – and fail – to recreate them at home. Historicaly this results in marital discord after the 6th straight meal of beans. Add a couple mojitos and you have yourself a meal.
If you find yourself in Miami head to Versailles followed by some Cuban music at The Ball & Chain bar. You can thank me later.
