Gyroscopic Investing

I guess we aren't the only ones who strategically hold a lot of cash...

Ms. Schroeder argues that to Mr. Buffett, cash is not just an asset class that is returning next to nothing. It is a call option that can be priced. When he thinks that option is cheap, relative to the ability of cash to buy assets, he is willing to put up with super-low interest rates, said Ms. Schroeder, who followed Mr. Buffett for years before she became his biographer.

“He thinks of cash differently than conventional investors,”? Ms. Schroeder says. “This is one of the most important things I learned from him: the optionality of cash. He thinks of cash as a call option with no expiration date, an option on every asset class, with no strike price.”?

It is a pretty fundamental insight. Because once an investor looks at cash as an option – in essence, the price of being able to scoop up a bargain when it becomes available – it is less tempting to be bothered by the fact that in the short term, it earns almost nothing.

Suddenly, an investor’s asset allocation decisions are not simply between earning nothing in cash and earning something in bonds or stocks. The key question becomes: How much can the cash earn if I have it when I need it to buy other assets that are cheap, versus the upfront cost of holding it?

[...]

For someone driven by a quest to find things that are undervalued, as Mr. Buffett is, knowing the price of cash as a call option is the key. The “call premium”? on the cash option is essentially the opportunity cost. It is the difference between what he can earn somewhere else and the nil return on holding cash, said Ms. Schroeder, addressing the crowd at the annual Investment Industry Association of Canada conference, after which she sat down for a Canadian exclusive interview.

Source: The Globe and Mail: For Warren Buffett, the cash option is priceless

Full Article: The Globe and Mail: For Warren Buffett, the cash option is priceless

Great post. Cash is probably the most underrated asset class I can think of. Even among PPers there is that concern about zero returns and we have people asking how far out on the yield curve you can go before it's not cash anymore. I used to be a fan of SHY/SCHO but more and more I lean towards T Bills or SHV.

Thank you very much for the interesting link. How important do you guys/gals feel the option value of cash is to the PP?

I love cash. It's dry powder to swoop in during another asset price decline for a rebalance. Plus the stability anchor in the portfolio during volatile markets. It's an extremely under appreciated and mis-understood asset by many.

It's all they accept at the grocery store.

No stocks.
No bonds.
No gold.

Just cash.