For investors, cash has a bad reputation. It doesn’t earn anything. Inflation eats away at it. It doesn’t grow. Central banks are printing too much of it. It just sits there. And if you spend it, you’re denying your future self the magic of compounding.
When markets fall and things look bad cash is the place to be, though. Unless you’re in wartime Germany, or Venezuela today, cash doesn’t lose value from day to day.
Even in normal times, cash isn’t always bad. In fact, sometimes cash is king. Let’s look at the benefits.
Cash Benefit # 1: Avoid market risk
From one day to the next, stocks, bonds and almost any other asset can rise or fall in value. You can never be sure what will happen – unless you have cash. Yes, over time, inflation will hurt the value of your cash. But from today to tomorrow, or next month, or next year, your cash will almost certainly be worth about what it’s worth today. Bad earnings reports, a stock market collapse in China, and the European Central Bank won’t hurt the value of the banknote in your pocket.
Cash Benefit # 2: The perfect hedge
A “hedge” is a way to reduce risk. In portfolio management terms, a hedge helps ease the pain when the value of an investment drops. It might mean owning two negatively correlated assets, or buying an asset that will move up when a particular stock or market falls.
A hedge is like a backstop. It stops things from getting too bad when your investments don’t turn out as planned.
The simplest way of hedging is to hold cash. No matter what happens in the market, the value of your cash will stay the same. But if markets fall, the buying power of that cash in your pocket increases: You can now buy more shares than you could just hours before.
As an example, imagine you had $50,000 invested in stocks, $50,000 in cash and the stocks dropped 5%. At the same time the value of your cash hasn’t changed. It might even be earning 1% interest. You would be down $2500 on your shares, but if you’ve gained $500 on your cash your overall portfolio would only be down $2000 – that’s a 2% decline instead of 5%. Cash has backstopped your portfolio against bigger losses.
Best of all, cash is easy to understand and holding it is free. You don’t need to make your broker richer by buying into some kind of complicated way to hedge.
Cash Benefit # 3: It’s there when you need it
Legendary investor Jim Rogers once explained his approach to investing like this: “I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up. I do nothing in the meantime.”
Rogers wasn’t talking about physical, actual cash lying in the corner. He was talking about something even better: An opportunity where the chances of making a good return are very high.
Those opportunities don’t come along very often. And even when they do, few investors will recognize them in time.
But if you don’t have cash, you can’t take advantage of these opportunities. Cash represents potential.
So, cash isn’t so bad. In fact, for an investor, it’s often the best possible option.