When Cash Is King

William Bernstein

YIELDS ON SAFE investments—namely Treasurys, certificates of deposit, savings accounts and money market funds—are in the basement. Yes, Series I savings bonds currently offer an annualized 7.12%. But that rate is only guaranteed for six months, plus regular purchases are limited to $10,000 a year.

“Where can I go for yield?” goes the cry heard throughout the land. Nowhere, of course. As put by money manager Raymond DeVoe Jr., “More money has been lost reaching for yield than at the point of a gun.”

Still, I have a more optimistic take. My contention: The safe assets in your portfolio have the potential to be its highest returning components.

Let me explain. Decades of data show that the owners of mutual funds underperform, on a dollar-weighted basis, their conventionally calculated time-weighted returns by a percent or two per year. Why? They chase performance, buying high and selling low.

Ever wonder who’s taking the other side of their trades? I don’t know for sure—but I’ve often suspected, by process of elimination, that it’s corporate insiders and very wealthy private individuals. That brings me to three quotes, all from the 1930s.

The first was supplied to me by economic historian Richard Sylla, who forwarded to me a pretty good description of how this happens. The description comes from Matthew Josephson’s Depression-era classic, The Robber Barons, which was first published in 1934.

During a market panic, writes Josephson, “There are many casualties, cruel transfers of individual fortunes. Yet he who possesses even a modicum of unimpaired capital is as one who watches the sand run down in an hourglass, while fully aware that he may, at the given moment, turn the glass over and begin the process anew.”

The second quote comes from a young Ohio lawyer named Benjamin Roth. He observed in 1931 that, “A very conservative young married man with a large family to support tells me that during the past 10 years he succeeded in paying off the mortgage on his house. A few weeks ago, he placed a new mortgage on it for $5,000 and invested the proceeds in good stocks for long-term investment. I think in two or three years he will show a handsome profit. It is generally believed that good stocks and bonds can now be bought at very attractive prices. The difficulty is that no one has the cash to buy.” (Italics added.)

Our final quote is from the great Benjamin Graham, author of The Intelligent Investor. In 1932, he wrote in Forbes that, “Those with enterprise haven’t the money, and those with money haven’t the enterprise, to buy stocks when they are cheap.”  

Graham’s phrasing is perhaps a little archaic. By “enterprise,” he meant cojones, which is perhaps also archaic, but more accurate. Summarizing all three, those with the most cash at a market bottom—Josephson’s “unimpaired capital”—are the ones taking stocks off the hands of the hapless masses.

In my mind’s eye, I can picture the modern incarnation of Josephson’s fat cat owner of unimpaired capital: someone with decades of investment experience who doesn’t necessarily possess the power to time the market—no one does—but who does know that the most spectacular returns are often earned in the first few days or weeks following a market bottom. She also has a large balanced portfolio, with a large amount of stocks that have benefited from high long-term returns, and also enough cash to sleep like a baby when things look the worst.

This point cannot be emphasized enough: If you have enough cash to pay your living expenses for many, many years, you’ll have no trouble holding onto your stocks for the long run and so reaping their rewards, and likely have some boodle left over to buy more during the inevitable fire-sales.

If the data on dollar-weighted vs. time-weighted returns are to be believed, our fat cat has most likely purchased her stocks in the form of mutual fund shares from panicked 401(k) and IRA owners, and she will likely sell them back to those same folks after the smoke clears and prices have risen. In the era of defined-contribution retirement plan investing, this is how the rich get richer.

The political economy of this upward redistribution of wealth is well beyond the scope of this essay. But for ordinary investors, the moral is clear: To prosper, one needs industrial quantities of patience, cash and courage—in that order.

Bill Bernstein is a recovering neurologist, author and co-founder of Efficient Frontier Advisors. He’s contributed to peer-reviewed finance journals and has written for national publications, including Money magazine and The Wall Street Journal. Bill has produced several finance books, including The Four Pillars of Investing, and also four volumes of history, the latest of which is The Delusions of Crowds. His life’s goal is to convey a suitcase full of books and a laptop to Provence for six months—and call it “work.”

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