If you were to examine Berkshire Hathaway's balance sheet during the last decade and a half, you'd come across an interesting anomaly: The amount of cash the Warren Buffett-led conglomerate holds is closely correlated to the stock market.
While many other investors were pouring cash into the market in 2006-2007, and thereby abandoning it in favor of stocks, Buffett was doing just the opposite, quietly allowing Berkshire's currency hoard to accumulate. Then, when the market crashed as a result of the financial crisis, leading most other investors to frantically convert their investments into cash, Buffett did just the opposite.
That Buffett is a contrarian won't come as surprise to anyone familiar with the Oracle of Omaha's philosophy. After all, one of his best-known sayings is to be fearful when others are greedy and greedy when others are fearful. But what may not be appreciated as widely is the role cash plays in executing his vision.
The "optionality" of cash
I think it's safe to say that many investors have been conditioned to think that holding cash is an imprudent tactic if one's objective is to build wealth. And, lest there be any doubt, there are, in fact, two good reasons for this belief.
The first is opportunity cost -- that is, if the market goes up by an average of 9% a year as it historically has, then the implied cost of holding cash as opposed to stocks is the forgone opportunity to realize a 9% gain. And the second is inflation, which is presently eroding the value of a dollar by roughly 2% a year.
But obsessing over these two downsides to holding cash leads one to overlook a much more critical upside -- what my colleague Morgan Housel, borrowing from Nassim Taleb's book Antifragile, calls "optionality":
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.
Unfortunately, far too few investors appreciate optionality's value. When most of us look at the cash balances in our bank and brokerage accounts, all we see is lost opportunity. Spurred on by short-term greed and action bias -- our ingrained preference for action over inaction -- we follow the crowd by converting our cash into stocks at precisely the wrong time, leaving little to no resources to deploy once stocks fall.
Cash, investing, and baseball
It's for these reasons that Buffett has said "lethargy bordering on sloth" is a "cornerstone" of his investing style, noting frequently in his annual letter to shareholders how few investments Berkshire made over the corresponding year. Further teasing out this idea, Buffett has analogized investing to baseball:
Investing is the greatest business in the world because you never have to swing. You stand at the plate; the pitcher throws you General Motors at 47! U.S. Steel at 39! And nobody calls a strike on you. There's no penalty except opportunity. All day you wait for the pitch you like; then when the fielders are asleep, you step up and hit it.
Of course, implicit in all of this is the ebb and flow of Berkshire's balance of cash and equivalents -- which currently stands at $50 billion. As Buffett waits for a pitch to swing at, the voluminous cash flow from Berkshire's subsidiaries accumulates. And then, when an agreeable pitch finally crosses the plate, often in the midst of a market calamity, he has plenty of power to swing at it.
The point here is that cash is king. You never know when the market will crash, leaving behind bargains for investors like Buffett (and hopefully yourself) with a stockpile that's ready and waiting to deploy when the time is right.
