We in Vanguard Investment Strategy Group read. A lot. So it was with great interest that I came across a recent article on Bloomberg about the earnings report from Warren Buffett’s company, Berkshire Hathaway.¹ The article said that cash holdings at Berkshire Hathaway recently topped $50 billion. Now, while Mr. Buffett is known for waiting for just the right opportunity to invest and then doing so decisively, there’s only one Warren Buffett.
It may be easy for us to cherry-pick his results and believe that, because he’s enjoyed such documented success, market-timing can work for anyone. The actual evidence of widespread investor success is sparse, though (for more, see Vanguard’s principles for investing success; in PDF, see pages 27–32). For the rest of us, market-timing is often a negative sum game, where we end up on the losing end of performance.
So as the “portfolio manager” of my family’s assets, I immediately looked at the portion of our portfolio allocated to cash and did some deep thinking. Am I in fact catering to an internal belief that I can pick the right time to invest in riskier assets and falling prey to the very studies that we and others have shown is a loser’s game? Or is cash actually part of my strategic asset allocation? If so, am I comfortable earning 1 basis point of yield in Vanguard Pennsylvania Tax-Exempt Money Market Fund? And what purpose does that allocation serve?
Or instead, should I just view the cash balance as a carve-out of my broader portfolio, serving as a liquidity pool and source of funding should I need it for planned or even unexpected spending, such as getting my driveway replaced this summer (sorely needed, by the way)?
Notes: Values are purely hypothetical and do not represent actual portfolios.
Fortunately (now’s the time to accuse me of shameless promotion of my Investment Strategy Group colleagues), Vanguard has a short piece on cash titled “Managing Cash in Your Portfolio.”² Its authors (and my colleagues), Sarah Hammer and Fran Kinniry, outline several considerations that I found helpful. First they write, “Two often-recognized downsides of holding cash are, first, that the money earns very little yield, and, second, that it remains subject to inflation risk.” As an example, since the start of 2000, the Consumer Price Index has increased an average of 2.41% per year (through July 31), while Vanguard Prime Money Market Fund has returned an average of 2.08% per year. Over longer periods, we’d expect cash to return modestly more than inflation, but the point remains. So the question of whether cash should have a permanent place in my portfolio as part of my asset allocation was answered—no, for those keeping track at home.
Second, they clearly state, “Cash should generally be thought of as separate from the rest of the investor’s portfolio … and should be invested in the vehicle that best matches the need.” In terms of answering the question “What should I do?” this is about as clear as one can get (see Figure 1 for an example). The point about the “vehicle” can’t be overlooked. If liquidity and stability are of critical importance, you should evaluate investments such as bonds carefully because of the possibility of loss of principal. Again, for those keeping score, the answer to my other key question about cash’s purpose is that it should be used for emergencies or scheduled spending from a portfolio.
All in all, after reviewing my portfolio and considering the place of cash, I’m comfortable in the size of our allocation and its core purpose. I don’t view it as part of my overall asset allocation. I am fine with it earning 1 basis point because I don’t want to take any excess risk with that pool of capital. And I will not use it to purchase higher-risk assets “when the timing is right.” While everyone has their own unique circumstances, hopefully you find this paper as helpful as I did when thinking about the role of cash.
And to answer my original question… Cash: What is it good for? Absolutely everything (that requires liquidity or short-term spending)!
Please remember that all investments involve some risk. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money by investing in such a fund.