Should you "be in cash"?

Of course you should have some portion of your wealth in cash (or cash-equivalent, but make sure the "equivalence" does hold: many thought of the weekly-auctioned muni bonds as such, and the crisis showed them they were wrong...) as a buffer against emergencies (no-penalties CDs, and ones with very small pre-withdrawal penalties like 60 days' worth of interest, may be a good way to keep most of that buffer -- I've seen that these days the best such offers, esp. from online-only banks, surpass 1.5% APYs, which sure beats the tiny-fraction-of-a-percent you can get from treasury bills and the like; just make sure you're fully covered by FDIC insurance!).  That's the part of your wealth, a small or big fraction as you may decide to make it, that's not "investable" (not with any safety and peace of mind, that is -- and those qualities are just priceless!-).  That's not what I'm talking about -- nor is the obvious fact that repaying any high-interest debt you may owe is probably a better use of any money you can spare than just about any other "investment" (with the possible exception of a good low-cost 401k with generous employee-matching of your contributions).

No, I'm talking about the "investable" portion of your wealth -- whatever's left after repaying high-interest debts, if any, and keeping a "safety cushion" in cash sufficient to give you whatever amount of surety and peace of mind you prefer.  Is there ever any case for keeping some fraction of your investable funds as cash?

A controversial topic, to be sure -- some are horrified at cash's low or even (in real terms) negative yields, other (typically with more experience) are adamant about "always having some dry powder" (readily investable cash) to take advantage of whatever weird opportunity batty-though-likeable Mr Market might be presenting them with next.  And (what a contrarian would I be otherwise?-) I agree with neither extreme position.

Let's start with a Warren Buffett quote (you can never go wrong with those!-), one which doesn't mention cash but is actually very relevant to this issue...:

The stock market is a no-called-strike game. You don't have to swing at everything--you can wait for your pitch. The problem when you're a money manager is that your fans keep yelling, 'Swing, you bum!'.

"Not swinging" (because the right pitch, i.e., investment opportunity, hasn't come yet) means "staying in cash" (with that fraction of your funds) rather than using them for inferior investments that don't meet your own personal criteria for margin of safety, probability of success, and potential returns. "Keeping some dry powder" no matter what means never "swinging" (again: for that specific fraction of your funds) no matter how perfect for you the pitch is.  Clearly, neither can be right: you should swing when the right pitch comes, but, not before!


At times in history when cash-equivalent holdings were (in real terms) devaluating in double digits (remember the '70s, anybody...?-), holding cash was a really serious ongoing cost... but, at times like this one, when the real rate for holding cash-equivalents is so close to zero, that doesn't really matter.

The only real cost of holding cash is the opportunity cost, which would occur if good investment opportunities occurred (with strong safety margins, probabilities of success, and expected returns) and were not taken. But that's balanced by the opportunity cost of not having investable cash, "dry powder", to take advantage of a good investment opportunity should one occur tomorrow -- the two considerations should just about balance each other out, removing any bias against "holding some dry powder" as well as any bias towards always holding some.

So, the decision should always depend on the case-by-case, bottom-up analysis of the actual pitches Mr Market is pitching at you all the time; if none are attractive enough to meet your criteria for margin of safety, probability of success, and profit potential, keep waiting (but don't keep waiting if and when the good pitches do come, just based on a fetish for always "holding some dry powder" -- if you never actually invest it, it's not really investable cash anyway, right?-).