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How I Think About Cash

I had breakfast with a financial advisor the other day. He's been an advisor for almost 30 years, watching people make decisions with their money during everything from the 1980s inflation spike to the dot-com bubble to the 2008 financial crisis.

I asked him what he thought was the biggest mistake people make with their money.

"Not saving enough." He said.

OK. Boring.

What's the second-biggest mistake?

"Not having enough cash. When chaos hits, nobody has enough cash," he said.

"What do you mean?" I asked.

"Interest rates have been low for 10 years. So no one wanted to hold cash last decade," he said. "But think about 2008. There were two types of people: those with secure jobs and those without. Then the economy crashed. Those with secure jobs didn't have enough cash to take advantage of once-in-a-lifetime investing opportunities. Those without secure jobs didn't have enough cash to keep their heads above water."

We left it at that. But later it reminded me of something Nassim Taleb wrote in his book Antifragile:

If you "have optionality," you don't' have much need for what is commonly called intelligence, knowledge, insight, skills, and these complicated things that take place in our brain cells. For you don't have to be right that often.

Optionality. That's the key. Cash gives you options other assets don't. It lets you take advantage of some situations and protects you from others. And you don't have to forecast what those situations might be. It's the closest thing to finance's get-out-of-jail-free card.

There's real value to that. How much? I don't know, but it's way more than the 0.001% I currently earn on my cash. The real "return" you earn on cash is its interest rate plus the value of its optionality. 

Most people don't think like that. They look at cash yielding 0%, subtract inflation, and assume they're getting a negative real return.

But when you think about the optionality cash provides, you get a completely different outlook.

Go back to 2004. Cash in the bank yields 1%. The S&P 500 is cheap. Which will make a better investment over the next nine years?

Well, stocks, of course. But a far better choice was holding cash until the world fell apart in 2009, and then cashing in your "optionality" to use that cash to buy cheap stocks.

Source: S&P Capital IQ, author's calculations.

This is a grossly cherry-picked example and created with the benefit of hindsight. But It shows the power of optionality. Cash held in the bank in 2004 only yielding next to nothing if you kept it there for good. If you deployed its optionality when the economy fell apart, its real yield, in terms of the value it provided you, was far higher than the advertised 1%.

So, why shouldn't you keep all of your money in cash awaiting the next crash? The longer you hold cash, the lower its likely optionality value is because it loses value measured against the market's long-term growth. If stocks fall 50% tomorrow, the optionality value on cash today is huge. If stocks triple over the next decade and then fall 50%, it's substantially less. (For more on how I manage cash in my portfolio, see here.)

But whenever I get frustrated at how little interest my cash earns, I remind myself that interest isn't what makes cash valuable. Optionality is. And the value of that option can be enormous. 

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Read/Post Comments (29) | Recommend This Article (90)

Comments from our Foolish Readers

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  • Report this Comment On September 27, 2013, at 10:23 AM, tomsutc wrote:

    Hi Morgan,

    Great article! I'm wondering though how this optionality works with automatic investments (aka dollar cost averaging)? If I'm investing $500/mo, in theory, I'll be both riding the market when it's high and buying more shares when it's low. Does that affect the "opportunity cash" amount you hold?

    I suppose the biggest assumption is that you don't lose your job with the next economic downturn. If you did lose your job, having the cash rather than lower-priced shares is obviously preferred.

    In my taxable accounts, I've recently switched from reinvesting dividends and cap gains to making those proceeds my "opportunity cash."

  • Report this Comment On September 27, 2013, at 11:21 AM, Schneidku40 wrote:

    Good article.

    Tomsutc, I imagine a dollar cost averaging strategy would yield a line somewhere between the blue and green in the article's graph. You're taking away both risk and possible reward.

  • Report this Comment On September 27, 2013, at 1:18 PM, AltReality11 wrote:

    Great article.

    I have thought of "cash" as opportunity. It does provide options because for investors it is the equivalent of "base metal" to the alchemists.

    As I recently commented elsewhere "I have striven to accumulate additional cash and then invested it into stocks and funds at “opportunistic moments” since 2004."

    Cash is under-appreciated. i do think it is appropriate to consider it to be a separate asset class.

    I'm not a market timer. I do cherry pick and deploy cash at opportunistic moments using a prepared list of possibilities.

  • Report this Comment On September 27, 2013, at 2:30 PM, ScoopHoop wrote:

    You nailed this. Nobody has savings anymore. I was one of the few investors who actually had cash in 2008-09, plus good job. I bought more stocks figuring it was a once-in-a lifetime opportunity. I bought stocks nearly every week from fall 2008 to spring 2009, not knowing at the time I caught the low of UNP at 48 per share in Feb 2009. I still have 20% of my net worth in cash. There is a reason why they say Cash is King. Cash allows you to be strategic in your investment style. You run the ship. When something happens, you call the shots. Without cash, there is no optionality, as you say.

  • Report this Comment On September 27, 2013, at 5:08 PM, Mathman6577 wrote:

    It's a good idea to have cash. Even thought it's only getting 0.4% I have about 16% of funds in cash including a six-month emergency account.

  • Report this Comment On September 27, 2013, at 5:42 PM, AlexCho wrote:

    Hey man that was really great. Good job, much better than the P/E article I read before.

  • Report this Comment On September 28, 2013, at 2:15 AM, rhoop wrote:

    The next time 'Diane' from my local TD Ameritrade calls me for not churning and burning the cash in my account fast enough I'll email her this article.

  • Report this Comment On September 28, 2013, at 11:29 AM, AMoors wrote:

    Excellent's been very difficult holding cash with such small yields. I guess I hadn't actually considered the total value of optionality before. I wish I had more cash on hand in 2009. Luckily what I did have, I put to work in the market. Thanks for all the education Motley Fool!

  • Report this Comment On September 28, 2013, at 12:39 PM, Saintmark01 wrote:


    Another terrific article. For years I have held 10% - 15% of my portfolio in cash. I assign an opportunity cost of 20% to the money - this is what I strive to make when I put it to work. Sometimes it takes a year or more to find the right opportunity so I'm reasonably sure I don't always achieve my target, but overall I'm pretty happy with the strategy. My latest was a pickup of a 1000 shares of LINE at the bottom. Two dividends later I was out with a quick 24% gain. It doesn't always work out this well, but having the cash in hand makes it possible.

  • Report this Comment On September 28, 2013, at 5:24 PM, daveandrae wrote:

    I've been buying and holding equities since June of 1998. Thus I speak from experience when i say Cash, with the sole exception of emergencies, is an irrational holding in the portfolio of the long term equity investor.


    I said it.

    Somebody had to say it.

    For once you strip out taxation and its evil twin, inflation, the real rate of return from cash is quite negative. Thus, the only sound reason that makes sense to hold cash is to believe the returns from all other assets classes will be even MORE negative.

    Thus, cash is not an investment.

    Its a hedge.

    The problem, of course, is FEAR, which believe me when I tell you is simultaneously contagious as well as paralyzing. Don't take my word for it. Look at the net cash position at the bottom of the last bear market. It was the at the largest percentage in the recorded history of the U.S. stock market!

    Truth be told, having amassed a small fortune that now ranks my family in the top 5# of net worth for my age, I can once again tell you from experience that those of us that went into the last bear market with a 100% equity portfolio with the stomachs to HOLD onto our portfolios through all of the vicissitudes of a gyrating market have done far better than those of us that made the more popular attempt to sell high and buy low.

  • Report this Comment On September 29, 2013, at 12:13 PM, hachmujt wrote:

    In Oregon I use Advantis credit union, they pay 2.25% on the first $25k in your checking. This is one option for a place to keep your cash.

  • Report this Comment On September 29, 2013, at 2:05 PM, bamasaba wrote:

    Morgan, please explain to me how this is different than trying to time the market. You always get anecdotal accounts of how great timing the market can work out, but I have never seen a convincing mathematical argument to validate it.

    Remember, there is always a cost for holding all that cash. This cost could be extremely significant, i.e. if you decided 2 years ago you would hold and wait for the next 'bottom.'

  • Report this Comment On September 30, 2013, at 2:22 AM, lowmaple wrote:

    daveandre: For example if one had 100 grand worth of stocks before the great depression and the other100 grand the other would probably been able to buy twice as much stock around the bottom with the hundred grand so I know cash is king. Of course after one spent the 100 grand one THEN would have no cash but would be better of than the first person. Oh and I didn't have the 100 grand but also rode it out.

  • Report this Comment On September 30, 2013, at 3:32 AM, daveandrae wrote:


    Low maple.

    I wrote this in my investment journal towards the end of the last bear market. Hopefully this will explain the difference between fantasy and reality.


    "At the top of the bull market in 2000, (s&p 500/1525) GE stock, priced at more than 55 dollars per share, sold for more than 4 times annual revenue, 10 times net asset value, yielded less than 1% in dividend income compared to 6.5% for a 2 year treasury note, and had a 12 month trailing p/e ratio well above 40.

    Nine years later, at the bear market low, (s&p 500/666) that very same stock, at a market price of 5.78, sold for less than 1 times revenue, at 60 cents to a dollar of its assets, yielded more than 6.76% in dividend income, POST CUT, against a 1% two year treasury bond, and at a 5 year average p/e ratio that was below 4.

    Year 2000

    GE stock - 1% dividend yield

    2 year Treasury bond - 6.5% interest rate

    Year 2009-

    GE stock - 6.76% dividend yield

    2 year treasury bond - 1% interest rate.

    Needless to say, the inversion in yields is striking to say the least.

    Never mind the fact that net earnings had more than doubled from 1998-2008, the trailing p/e ratio of GE common has now compressed by more than 80 PERCENT! From 23, to 3.26.

    Meanwhile, over the last nine years, short term treasury bond yields, have done damn near the exact opposite. Offering a very attractive, and competitive 6.5% yield at the bull market peak of 2000, to virtually no return at all as of last week.

    Of course, the general public is currently behaving in a manner that is perfectly "normal"..... piling into Government debt as if the world is coming to an end. Shedding equities to the tune of 100 BILLION dollars over the last 12 months, and more than 56 BILLION dollars over the last 2 WEEKS!!!

    More than 4 TRILLION dollars is currently tied up in money market mutual funds with the fed funds rate at a ZERO%. Thus, I now know, and have seen what an overpriced, ridiculously expensive stock AND bond market looks like, as well as what a generational low, dirt cheap stock market looks like. Or better yet, when an outstanding business is simply being given away, with NO takers.

    Right now, the general public is so panic stricken, that they would rather buy treasury bonds at a ZERO percent after tax/inflation coupon than a AAA rated 7% dividend from General Electric stock. "

    March, 2009.

  • Report this Comment On September 30, 2013, at 8:16 AM, devoish wrote:


    It sounds to me like "optionality" is a pretty close match to something similar called "timing the market".

    Best wishes,


  • Report this Comment On September 30, 2013, at 9:04 AM, cmfhousel wrote:

    Market timing = "My black box tells me stocks are going to fall Tuesday."

    This = "History says stocks are going to fall by a lot sometime in the future. I don't know when, but they will. When they do, I'll be prepared"

    Big difference.

  • Report this Comment On September 30, 2013, at 9:19 AM, bamasaba wrote:


    I agree that your empirical method for timing the market is different than an ad-hoc method of just winging it. However, it is still timing the market, you are just using a rule-set to do the timing.

    As I said, it sounds like an okay strategy, but it's hard to determine how well it would work in practice. It would be interesting if you could show under what conditions your rule-based market timing works better than averaging in (and vica-versa).

  • Report this Comment On September 30, 2013, at 9:48 AM, cmfhousel wrote:

    <<However, it is still timing the market, you are just using a rule-set to do the timing.>>

    But there's no timing involved. Saying the market will fall at some point in the future is much different than saying it will fall on Tuesday.

  • Report this Comment On September 30, 2013, at 10:05 AM, bamasaba wrote:

    Morgan, I believe we are arguing over semantics here. In my mind, market timing is fundamentally the idea that you can outperform an 'average in' type strategy by instead buying on troughs and/or selling on peaks. You have presented a rule-based method of doing just that.

    I really like your rule-based strategy because it can be analyzed. However, my guess is that if you do the careful analysis your rule set will fare no better than an average in approach, perhaps worse.

    If that were not the case, and rule-based market timing did in fact work well, It would be very interesting. However, I think we would have heard about it before, as countless smart people have spent a lot of time trying to 'beat the market.'

  • Report this Comment On September 30, 2013, at 11:44 AM, daveandrae wrote:

    Morgan writes....

    Market timing = "My black box tells me stocks are going to fall Tuesday."

    This = "History says stocks are going to fall by a lot sometime in the future. I don't know when, but they will. When they do, I'll be prepared"

    Big difference.


    Rejoice in thy youth, young man.

    Having experienced two "market crashes" as well as several "flash" crashes over the last fifteen + years I can tell you from gut wrenching experience that you have no idea what "prepared" really means.


    You, Sir, are deluding yourself if you believe you'll still want to buy stocks after watching six figures of net worth evaporate by, oh, say 80% over an 18 month period.

    Not only will the market go down far lower than you could have imagined, not only will your purchasing power have long been exhausted, but thoughts of capitulation will begin entering the outer portions of your mind.

    Truth be told, sooner or later the stock market forces each of us into the teeth chattering, gut wrenching, fetal position in which the only thing successful people say to their will and sinew while everyone else is jumping off the Titanic is HOLD!

    Hold! for just one, more, day.

    Most people don't have the stomach to hold onto to their portfolios through that moment. Most people fall under the toxic illusion that their stocks are going to zero and just want out. This is yet another reason why most people aren't wealthy.

    They don't deserve to be.

  • Report this Comment On September 30, 2013, at 11:50 AM, TMFDanielSparks wrote:

    Optionality. It's an awesome concept. I've slapped it on my whiteboard. I wish I had been able to express that term in an article I wrote a few months ago on why margin is dangerous:

  • Report this Comment On September 30, 2013, at 1:58 PM, AltReality11 wrote:


    Your comments are reminiscent of my former adviser's comments, He and she were always advocating that I be "fully invested." I decided in 2001 that was not good advice, but it took a few years to fully implement an alternative strategy. it does take time to amass excess cash and it takes time to study the opportunities and prepare a list of "desirables." It also takes time for the world to align with that list. But in a year or so, it does happen!

    I discovered that there is a middle ground, or what I prefer is a "hybrid" approach which uses regular, automatic investments via a DCA strategy coupled with accumulating excess cash and then deploying it opportunistically,

    I find it interesting that so many people talk about the "Buffett Way" and than operate in exactly the opposite manner. Mr. Buffett is known for accumulating cash and then deploying it when opportunities arise. Mind you, I also know that he has said that reading 500 pages of company data each day is is beneficial. In other words, sitting back and expecting money in a bank account or money simply tossed at the market to make one rich is not a good strategy.

    I do put my money where my mouth is. I've regularly invested via DCA and that is designed to meet my minimum requirements in retirement. I also take any excess cash and then invest in opportunistically into specific companies or at specific times. I've been able to increase my retirement accounts each and every year by about 39% annually since 2006. That amount includes cash, which as we know is getting a return of 1 to 2% annually.

    I'm happy to let my powder lie safe and dry so I can use it to my greater advantage.

    Sometimes, I think that these investing stories are reminiscent of Aesop's fable about the "tortoise and the hare." I'm moving slowly toward my second $million.

  • Report this Comment On September 30, 2013, at 11:27 PM, Chontichajim wrote:

    I look at my total portfolio and expect cash to grow (maybe only slightly) as market values increase, while I expect cash to shrink as market values decrease.

    If that is not happening I spend more time/research trying to find what (and what portion) of a position to sell or buy.

    Cash looks high in 2013 when I consider dividends/interest, but by only operating with a 2-20% range of cash I am still mostly invested.

  • Report this Comment On September 30, 2013, at 11:51 PM, daveandrae wrote:


    Sounds like you had some good advisors.

    Here is my September 28th 2013, year over year and four year aggregate investment performance.

    Asset allocation

    100% equity-

    Turnover ratio

    3-4% ( a portion of the return was monetized into tangible productive assets and the repayment of debt. )


    Harley Davidson – 54.76%

    Dow Chemical – 39.93%

    Pfizer - 20.27%

    General Electric - 9.45%

    McDonald’s - 9.39%

    Total, aggregate return on invested capital –


    S&P 500 –


    Four year average-


    S&P 500-


    One Mo Time......With the sole exception of emergencies, "cash" is an irrational holding in the portfolio of the long term equity Investor.

    Nuff said.

  • Report this Comment On October 01, 2013, at 4:19 PM, damilkman wrote:

    I never considered saved cash for investment. It is there for security and security only. If I use my cash to to invest in what I believe is a cannot miss opportunity and then I need it for a disaster, I am in the same boat as if I had never saved it in the first place. My cash is for when the world burns down and I need to pay my bills.

    I believe a more accurate statement is liquidity or access to cash. If I really see what I believe is a can't miss opportunity I would hate to use my cash reserve. If I do not want to opt out of some other position and I have great credit, someone will loan me the money.

    In my opinion this is the real difference between the haves and the have nots. The haves have access to capital because they have generated a level of trust with the creditor market they are good to pay it back. Thus they are able to take advantage of opportunity even if they do not have the cash at hand. Those who have not built up this trust cannot. If I have a great reputation, I do not have to have a nickel in the bank. The bank will happily loan me all the money I want.

  • Report this Comment On October 02, 2013, at 10:06 AM, Schneidku40 wrote:

    I've been saving my cash for the last two months in preparation for this budget showdown. I was looking for the market to take a little dip in response so I could get a better buy-in point.

    I am like Altreality, I like to keep a little cash in reserve for these downturns. My normal method is to make contributions to my Roth IRA when the market is in a correction. I started investing four years ago and these small corrections have come pretty regularly 1-2 times a year, so that's when I deploy my cash.

    It's sort of a hyrid way of trying to invest low while also averaging inputs over the course of a year.

  • Report this Comment On October 04, 2013, at 3:50 PM, PenguinTrap wrote:

    I didn't have a name for it, but I exercised it from September 2008 to through 2009.

    My main regret is that I kept too much cash on the sideline in early 09...but that only became obvious in hindsight.

    I've continued building my cash and with it, optionality. Ive read the comments here and I think some miss the point. This isn't market timing...because cash allows you to do so much more.


    I bought a vehicle in Dec 08 before GM went bankrupt...they were (almost literally) giving new vehicles away. Today's blue book value on the used car is about 500 bucks less than WHAT I PAID 5 years ago. That's optionality. It hasn't mattered what the S&P or Bond Market has done since then. I took the option to enjoy a tangible good essentially free from depreciation this entire time. There is a real, measurable return here (I haven't calculated it but it could be done).

    Similarly, we bought a vacant house in 2009 (April) for a 40% discount to it's listing price in April 2008. Same damn thing. We had the cash to get it done.. (plus the necessary credit score)....and the stomach for it (entirely different subject). Was this perfect timing? Nope. Prices fell for another year or two in our area. Was it great timing? Yup. We've rode the wave up in a house we love. This return was measured in an appraisal during a refinance last spring...not including having a nice place to call home.

    Having the $ to make these options available exist outside the equities markets. I think that's the entire point.

    Meanwhile, a portion of my pay check goes into my boring, low cost 401k index funds month in/month out. If I don't need it for another 20 years, why worry? I can sleep well at night with some cash on hand, a house with a great loan to value ratio (if things get frothy in real estate again), a 5 year old car that is paid off..and cash earning 0.1% for the next emergency or opportunity.

    Glad I now know what to call this behavior. I'm not cheap...I'm "exercising optionality".

  • Report this Comment On October 04, 2013, at 6:40 PM, comissar wrote:

    Keeping cash on hand for rare events such as a market correction give you the opportunity for incredible deals such as stocks at 20-30% off. But you lose the 7-10% per year you might have been making while waiting for those opportunities to show up, and it assumes that you will recognize the situation for the opportunity that it is and take advantage of it in a timely fashion. I prefer to remain fully invested as long as I can find something worth investing in. Now if you just don't see anything worth risking your money on, then by all means, sit on the cash until something comes along. And of course, I'm primarily talking about investment/retirement money - household finances and emergency savings are an entirely separate matter.

  • Report this Comment On October 04, 2013, at 9:00 PM, enginear wrote:

    This is all very true, but it says little about how to manage your cash. This is an important part of investing... very dull, but important. How much cash to keep on hand, and when to plunk it down for something that will appreciate, or pay dividends are tricky questions.

    For some, cash is coming in regularly in amounts easy enough to squirrel away (those w/ good jobs & low expenses), others have higher expenses, yet others have no real income (retirees use cash, from their portfolio, to buy gas/groceries). It depends on your situation, but its always nice to keep some cash on hand. Its NOT a good idea to keep too much cash.

    Opportunity cost, as the economists refer to it, is real, but sometimes the opportunity is spectacular. 2009 was one good example, but if you had just 'bought in' in late 2007 you got clunked, and the cash portion of a portfolio fluctuates with buys.

    Best bet... get lucky with your timing. Then you're the cocktail party genius.

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