Lessons From America’s Greatest Investment Tragedy

The incredible value of cash.

Morgan Housel
Morgan Housel
May 25, 2014 at 10:28AM

Benjamin Roth wasn't a professional writer or investor. But he wrote one of the most instructive investment books ever published.

Roth, an Ohio lawyer, kept a diary during the Great Depression, writing several times per week from 1931 through the early 1940s. His son published it in 2010. The entries are rarely more than three sentences, but vividly describe life during America's worst economic tragedy. One entry from April 6, 1932 simply states, "Insanity and suicide among prominent business men is on the increase."

Roth was fascinated with the stock market, and how smart people could be destroyed by it. He repeats, over and over again, a simple investing lesson obvious to everyone who lived through the depression: the incredible value of having ample cash in the bank.  

July, 1931: "Magazines and newspapers are full of articles telling people to buy stocks, real estate etc. at present bargain prices. They say that times are sure to get better and that many big fortunes have been built this way. The trouble is that nobody has any money."

Aug., 1931: "I see now how very important it is for the professional man to build up a surplus in normal times. A surplus capital of $2500 wisely invested during the depression might have meant financial security for the rest of his life. Without it he is at the mercy of the economic winds."

Dec., 1931: "It is generally believed that good stocks and bonds can now be bought at very attractive prices. The difficulty is that nobody has the cash to buy."

Sep., 1932: "I believe it can be truly said that the man who has money during this depression to invest in the highest grade investment stocks and can hold on for 2 or 3 years will be the rich man of 1935."

June, 1933: "I am afraid the opportunity to buy a fortune in stocks at about 10¢ on the dollar is past and so far I have been unable to take advantage of it."

July, 1933: "Again and again during this depression it is driven home to me that opportunity is a stern goddess who passes up those who are unprepared with liquid capital."

Aug., 1936: "This depression has indelibly impressed on my mind one thing, and that is the value of having on hand sufficient capital to cover emergencies. My experience as a lawyer shows that a large proportion of business failures are caused by lack of capital rather than by lack of technical business knowledge."

May, 1937: "The greatest chance in a lifetime to build a fortune has gone and will probably not come again soon. Very few people had any surplus to invest—it was a matter of earning enough to buy the necessaries of life."

Keep in mind what happened during this period. The Dow Jones fell 89% from 1929 to 1932, and unemployment shot to 25%. Those without enough cash to endure were forced to liquidate assets for pennies on the dollar. Then the market rose almost fivefold from 1932 to 1937 in the biggest five-year rally in history. Several blue-chip companies increased 10 or 20 times over. Those without cash (and guts) saw the greatest investment opportunity of their lives waltz right past them.

This story repeats itself throughout history, just not as severe. During booms, all people care about is return, and complain about how worthless cash in the bank is, earning a puny yield. During a crash they realize that nothing is more precious than cash in the bank, even if you had to sit on it for years earning that puny yield.

We're doing this again today. So many are livid that their cash in the bank earns no more than 0.01%, losing money every day to inflation.

I think this is a terrible way to think about the value of cash, and it causes people to chronically underestimate its real worth. Cash doesn't earn much today, but it gives you options in the future. Over time, that potential can more than offset the dismal yield earned today. If earning 0.01% today allows you to become a financial vulture in a future market crash -- or avoid becoming a desperate seller -- then you're really earning far more than 0.01% on your cash today. It's hard to convince some people of this, because all they see is the advertised 0.01% return. But having options has real value. "Cash combined with courage in a crisis is priceless," Warren Buffet once said.

Most investors have never heard of Arnold Van Den Berg, but he's one of the greatest investors of our time. Since 1974, Van Den Berg's fund has returned 14.5% a year, versus 11.9% a year in the S&P 500. $1,000 invested in his fund in 1974 would be worth $196,000 today, versus $80,000 in the S&P.

On average, cash has made up more than 20% of Van Den Berg's assets, compared with closer to 5% for the typical mutual fund. He was once asked why, as a stock-picker, he hoards so much cash. "Think of it this way," he said. "If we sit in cash and wait for a $15 stock to get down to our $10 buy point, then when it eventually goes back up to $15, we get a 50 per cent return on our investment. We think this more than makes up for the few months or quarters we might have to wait in cash, even if cash paid no yield at all." When you come to terms with how common market volatility is, this attitude can be a huge advantage.

"That cash you're holding today is the raw material of tomorrow's superior returns," Van Den Berg said. He understands what it took a depression for most to learn.

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