Fund managers are apparently winding up funds and returning cash to investors to avoid the coming crash. Bill Gross is telling us sharemarket risk is at its highest level since the financial crisis. You could be forgiven for feeling gloomy.
Reading all of this pessimism got me thinking about an article I wrote for the AFR a few years back, Warren Buffett Warns on the Perils of Cash. I'm reposting it in full below, because the logic is just as compelling today. But while you are reading it, remember it was written in March 2015. And think of the cost had you sold the whole portfolio back then.
Warren Buffett Warns on the Perils of Cash - March 2015
Albert Einstein once said: "If you can't explain it to a six-year-old, you don't understand it yourself."
The ability to simplify complicated concepts is a common trait among geniuses. Whether in science, architecture, engineering or investing, the smartest people are able to provide clarity to complexity.
Often it is not the idea itself that is the stroke of genius. We will read or hear something explained and exclaim, 'Well, I could have thought of that'. We could have. But we didn't. Because it is the ability to pull that one idea out of the thousands of alternatives and say this is the one thing you need to be thinking about that makes someone truly insightful.
And that's why Warren Buffett's annual letters to shareholders are so eagerly anticipated.
None of us expect a great stock tip or a specific idea that is going to make us a fortune. What we get, every year without fail, is a distillation of a very complicated world into one or two key principles that invariably end up being more important than all of the noise.
This year's letter was no exception. And the lesson was on the perils of holding cash. Comparing the 11,196 per cent return from holding the S&P500 over the past 50 years with an 87 per cent depreciation in the value of a dollar of cash during the same period, Buffett reached an inescapable conclusion:
"Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions."
The comparison of the sharemarket with cash is a slightly incongruous one. You would have made a lot of money invested in equities but each dollar still buys you 87 per cent less than it did 50 years ago. And, presumably, you would have made a decent amount of interest had you just held cash in the bank.
But the point stands. By investing in cash you are certain to lose buying power over a long period of time.
It is a timely piece of advice and intentionally so. Not a day passes without someone opining on the perils of central bank influence on asset prices and the coming crash when the punchbowl is removed. We're worried about deflation – the world is turning Japanese. We're worried about inflation – how can all of this money printing not result in rampant inflation? The developed world has an ageing population – how can we possibly support all those retirees? We're worried about rising interest rates, falling interest rates and China's economy collapsing.
Don't get me wrong. These are all justified concerns and issues the world is going to have to deal with. I have no doubt Buffett is thinking about them and knows a lot more than you or I. But, as usual, it's his ability to see the forest for the trees that sets him apart.
These risks we spend our lives fretting about pale in comparison to the risks associated with holding large amounts of cash for long periods of time.
"[The long-term investor's] focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities."
While reading about Grexits, quantitative easing and ghost cities in China, we must keep this fundamental tenant front and centre of our thinking. Long-term savings should be tied up in real investments that protect, and hopefully increase, our purchasing power over time.
It really is as simple as that.
Hi Steve, I think that you consider Technical Analysis... therefore the All Ords....... March 2015 was the high (Double top) ~6000. The market then fell ~18% to ~5000 major support. All Ords recovered to ~6000. It is now still below the March 2015 high. I believe that there is very strong case for holding cash but not forever. Another point that gets oversold is if you take out the ten best positive days on the sharemarket... Imagine the opposite take out the worst negative ten days on the sharemarket. No one is perfect but I believe that there is very strong case for holding a varying level of cash in a portfolio (say 50% - but not forever. Rick Huxtable (Investment Planning)
great piece steve
Hi! Sþeve, great article, putting it simply when you hold cash over the long term all you have is cash. Where equities, one can buy and sell as trends and company fortunes change so constently updating your portfolio which assists ones changing lifestyle, long term history shows a far better growth platform.. Ross Salmon Forager Investor