Whenever the going gets rough in the markets, some portfolio manager will say, "In times like these, cash is king." That's half wrong. If you have to say, "in times like these," it's already too late to be advocating liquidity. Cash is always king.
Of course, cash pays no dividends, earns next to nothing and loses value to inflation. But you should always keep at least some of it in your portfolio. Why? Because you'll be doing the same thing all great investors do: preparing for inevitable rainy days in the markets.
Take Warren Buffett. His Berkshire Hathaway Inc. usually keeps about 10% of its vast assets in cash. In the summer of 2008, the company had $31 billion (all currency in U.S. dollars) in cash. When markets crashed that fall, Buffett got a steal of a deal when he bought $5 billion worth of preferred shares in troubled Goldman Sachs . This spring, Goldman redeemed the shares. Berkshire's total profit, including dividends: more than $1.5 billion. Heading into this past summer, Berkshire had $48 billion in cash. When markets slumped in August, Buffett went bargain hunting again, and bought $5 billion worth of shares in Bank of America .
Maintaining a substantial cash position benefits you in two ways: It cushions you during a market plunge, and boosts your returns if you buy near the bottom. Suppose, in 2005, you invested your money in a fund that tracks the S&P/TSX composite index, when the index was trading at about 10,000. The index soared to 15,000 in 2008, then slid to below 8,000 in March, 2009. This past August, it had made it back to about 12,000, giving you a gain of 25% since 2005. But if you'd kept 10% of your holdings in cash in 2005, then deployed that portion in March, 2009, your gain would have been 28%.
Of course, this assumes that you picked the bottom clean and put all your cash to work in March, 2009. For many investors, that's a stretch. But training yourself to be fearful when others are greedy, and greedy when others are fearful—to paraphrase Buffett—is part of the education of a good investor.
If you're a sharp stock picker in addition to getting your timing right, your returns could be even greater. Bank of Montreal's shares have more than doubled since March, 2009, and they've paid a fat dividend. Teck Resources has gone up more than tenfold.
Exercising cash discipline also means you're doing almost the exact opposite of what many poor investors do. When markets soar, they often borrow by buying on margin. When stocks start to fall, their brokers ask them to top up the collateral in their accounts for the margin loans. If those investors have no cash, they have to sell shares, which makes the market decline worse.
You hear an awful lot from Bay Street about staying "fully invested." And when stocks are going up, it's always tempting to throw more money at them.
Resist. Volatility is probably going to be with us for a while, and that will make stocks cheap during market dips. Be ready and be liquid. That's how you get an edge.
VALUE Mega Brands Forward price/earnings ratio 12.0 Mega is famous for its Lego-like building blocks. It's infamous for its brush with corporate death in 2007, after a product recall and a poor acquisition. But the company is looking promising again, even though its share price has been lower recently than when a group of big value investors came to its aid in 2008. Mega's products are selling, retailers want more and its balance sheet is stable. The shares should start to move soon. Disclosure: I now own some.
GROWTH Opmedic Group Three-year revenue growth 56% Trying to find a growth stock in this economy is like trying to find sushi at a tractor pull—not impossible, but not easy. Hard digging has nonetheless yielded Opmedic. The business: mainly fertility treatments for couples. Not recession-proof, but not a totally discretionary expenditure for aging career women and their stressed spouses, either. Fun fact: 40% of infertility is caused by male impotence. Opmedic went public six years ago and has been cranking out profits. It pays a dividend and insiders own more than half of the shares. Break out the cigars. Here comes a bundle of joy.