Benjamin Graham said “you are neither right nor wrong because the crowd disagrees with you.” Rather, “you are right because your data and reasoning are right.” He also emphasised that “the right kind of investor [takes] added satisfaction from the thought that his operations are exactly opposite to those of the crowd.” His most renowned employees and students, such as Warren Buffett, have therefore tended to be cautious when others are confident, calm when others are fearful – and deliberate at all times. How can an intelligent investor apply this principle in late in 2003? By considering the case for cash. The All Ordinaries Index is presently near its twelve-month high and not far from its all-time maximum. Further, according to Brisbane’s The Courier-Mail (9 August), the Australian Investors’ Association has forecast that the prices of Australian shares will rise significantly during the next year.

This prediction is based on a survey that shows record levels of bullish sentiment. The survey finds that 72% of advisers and 54% of their clients believe that things are going well and will get better. Only 4.1% of clients and 1.8% of advisers are bearish.The case for cash does not mean that the investor should sell everything and stuff it under the mattress. It doesn’t necessarily mean that you should sell anything. It means that you should resist the temptation to remain “fully invested” at all times; that if value is difficult to find, then you should happily hold cash; and (perhaps by selling assets whose prices exceed their values by a wide margin, or by retaining cash that comes your way) that you should accumulate cash. If, as Mr Buffett once put it, “investors pay a high price for cheery consensus,” then the case for cash is that you keep your powder dry and wait for better opportunities down the track. Alas, managers employed by major investment institutions can pay a heavy price for undertaking unconventional but conservative actions. Keeping one’s powder dry, in other words, can be safe for investors but hazardous for funds managers.

Bloomberg News (2 September 2002) reported that a senior manager resigned from Fidelity, one of America’s largest investment institutions, because he believed that a decrease of his fund’s cash holdings (which Fidelity demanded that he undertake) would harm unit holders. In his letter of resignation he stated that “to reduce the [fund’s] cash position today would be inconsistent with the first principle of our code of ethics, namely, the injunction to put unit holders’ interests first … To take such action … [would] entail large-scale purchases of stocks without appropriate consideration for the risks involved.”

Before his resignation this manager allocated 32% of the fund’s assets to cash (one of the highest in the 4,500 funds monitored by research firm Morningstar). One month after his resignation the cash weighting had fallen to 12%. Fidelity’s largest fund, Magellan, is America’s largest, and at its peak in 2000 boasted nearly $110 billion of assets (an amount roughly equivalent to the U.S. current-account deficit.) According to Fidelity’s website, in July 2002 Magellan’s cash position fell to its lowest level in more than two years. The fund allocated 0.5% of its assets to cash on 31 July, down from 3.2% in June and 7.4% in January.At many times in the past, cash has been a sensible provision and a long-term luxury. To insist upon good quality and low price is to forego the vast majority of investment opportunities (i.e., good quality at a high price, mediocre quality at a high price, mediocre quality at a low price, etc.) available at any given point in time. This stance means that the intelligent investor will often be an investor-in-waiting who takes maximum advantage of excellent opportunities on the infrequent occasions that they occur.

In Mr Buffett’s words, “when much of the rest of the investing world, burdened by debt, encounters some crisis forcing a panic, we are standing there with no debt and a loaded gun of cash ready to bag rare and fast-moving elephants.” Balancing this long term advantage is a short-term disadvantage. Most people, unfortunately including most investors, mistakenly believe that cash is an investment. Not so: unless it is lent it generates no income (reward) in return for the risk (such as loss, theft, confiscation, etc.) that inheres in holding cash. It is the lending of cash, not its burial in the back garden, which constitutes an investment; and the purpose of such an investment is to convert an inert asset into a stream of income. Cash lent to banks is an interest-bearing asset whose nominal (as opposed to inflation-adjusted) value never falls but rarely rises appreciably. Over the past year the average Australian money-market account has yielded 3.7% (1.6% net of change in the Consumer Price Index) before tax. According to Jeremy Siegel, a professor of finance at the Wharton School of Business at the University of Pennsylvania, between 1802 and 1997 the purest form of cash (i.e., gold) returned 1.2% per year before tax and the CPI. Bonds generated bigger (4.9%) and companies the biggest (8.5%) streams of earnings. At most milestones in the marathon of investing, in other words, cash runs dead last and by a wide margin. Accordingly, the greater (in percentage terms) the percentage of one’s long-term portfolio held as cash, the more a floor will be placed below and a ceiling above one’s results.