It appears that I have become caught up in a spirited discussion regarding holding cash in investment portfolios. However, I believe that my position on this important subject is being misrepresented. Therefore, I felt compelled to offer this article for clarification of my true position and beliefs on the utilization of cash in portfolios.
My inspiration was a recent article published by Adam Aloisi titled “Should the Retired Dividend Growth Investor Really Be Building Cash?”
In his article Adam provided a link to a recent article published by Regarded Solutions titled “Retirement Strategy: Having Cash Is Not a Sin, It Is Smart!”
And he provided a link to a previous article of mine I authored on December 12, 2013 titled “Why It’s a Mistake to Hold Cash in This Market” and finally a link to a previous article he authored on December 13, 2013 which he considered a counterpoint to my article which he titled “Why Holding Cash May Not Be a Bad Idea in Today’s Market.”
At this point, and before I go on, I want to be clear that I have a great deal of respect for Adam and his work, even though we don’t always agree on investing matters. Furthermore, I also have a great deal of respect for Regarded Solutions and his work. However, this rebuttal and continuing debate is between Adam and I, as Regarded Solutions is, in a matter of speaking, an innocent bystander.
In both of Adam’s articles, it is my position that he unintentionally misrepresented my views on cash and investment portfolios. I wrote a long retort in the comment stream of his first “counterpoint” article and any interested reader can find it there. Adam also provided rebuttal comments to my rebuttal comment that you can also read, if you choose.
The Difference between Going to Cash, Cash Reserves and Building Cash
Going to Cash: I Consider It a Mistake to Liquidate Stocks Based on Fear
My first article that Adam rebutted, or to use his words “themed as a counterpoint” was, in my opinion, neither. My article was addressing liquidating all or a portion of an equity portfolio for fear of a market crash. We had just completed the fifth year of a strong bull market and there was already a pervasively strong sentiment for an imminent market crash. My main point underpinning my article was that I considered it a mistake to move to cash in order to avoid a market crash just because the market had gone up for an extended period of time. My position was that “time in the market” is more valuable than attempting to “time the market.”
Furthermore, my article was about investing in great businesses at sound valuations regardless of market levels. Moreover, I was specifically addressing the capital portion of an investor’s portfolio that was dedicated to equities. Additionally, I wrote about the difference between investing and speculating. And, I also pointed out that it is a market of stocks and not a stock market. Therefore, my contention was that regardless of market levels, there are always attractively valued stocks that can be found. I concluded the article with the following paragraph:
“For all the reasons stated above, and others, I believe it is always a mistake for true investors to hold cash based on an expectation of what the stock market might do in the near-term future. Instead, I recommend building portfolios whether it is for growth and income, income or growth alone, one company at a time. Study and analyze the businesses you are interested in and make your long-term investing decisions on those merits. You don't have to buy at perfect bottoms, and you don't have to sell at perfect tops, in truth, that cannot be accomplished except by chance. Identifying great businesses at sound valuations is not only all you can hope to accomplish, it is something that you can accomplish with a little work, effort and intelligent thought. Invest wisely.”
Cash Reserves as a Portfolio Allocation Strategy
Many readers chimed in on the comment thread of the article I wrote on December 2013 talking about always having a portion of their total portfolio in cash reserves. However, this was not the cash I was referring to in my article. There are many investors that will always keep a portion of their total portfolio in cash reserves for emergency purposes. These cash reserves are not the capital available for long-term investment that I was discussing. I was only referring to the portion of an investor’s capital that was earmarked for long-term investment in equities, and therefore, also excluded capital allocated to fixed income.
Always keeping some cash on hand for emergency purposes is something I consider prudent. However, and to repeat, I do not consider this investable capital. Cash in that context has a different purpose and function, and serves as an appropriate allocation component of an overall portfolio construction. Historically, this type of cash has rarely generated high total returns. More importantly, it is not supposed to. This type of cash is kept available for emergencies, or for a specific planned outlay such as the need for a new roof on your home, etc. Cash that might be needed over a short period of time should never be exposed to any level of market risk, at least in my opinion.
Most importantly, building cash is not the same as liquidating your equity portfolio and going to cash for fear of a pending market collapse. The following excerpts from Regarded Solutions’ recent article clearly referenced the fact that he was not advocating panic selling, and that he was continuing to reap the dividend income his dividend growth portfolio was generating (emphasis added is mine):
“Tell me the worst that can happen? In my mind, missing a dip but NOT selling from panic, and building cash while the dividend checks keep rolling in makes lots of practical, conservative sense when the market is so easy to read, as it is now.
So if I am wrong, the worst that will happen is you miss a buying opportunity. That's it in my mind. If that is the worst that can happen, then during this market environment, I choose the less risky path of building cash and keeping an eye on the issues and headwinds that this market is facing.
Trust me, the stocks will still be there when the dust settles. It ain't that critical to rush into anything right now.”
With my own personal investment philosophy, I am usually and even always in a constant state of “building cash” by collecting the dividend checks from my portfolio. Personally, I prefer the strategy commonly referred to as “collect and invest” regarding my dividend distributions. Other investors prefer implementing DRIP plans (dividend reinvestment plans) and I consider both of these strategies prudent approaches. On October 16, 2015 I authored an article titled “The Best Way to Reinvest Your Dividends for Retirement” where I discussed both strategies.
Importantly, as regular readers know, I do not believe in market timing, instead, I believe in time in the market. However, I do believe in paying attention to how the market is currently acting. In other words, I don’t try to time the market, but I do occasionally listen to what it’s telling me. The downward spiral in stock prices that is currently occurring represents a case in point. I do have some cash that needs to be invested, and I am currently assessing many interesting companies that have recently come into my valuation ranges or getting close to it as a result. Therefore, my current posture for my available cash could be called watchful waiting.
However, watchful waiting does not mean idly sitting by in a state of fear or indecision. While I am watchfully waiting, I am simultaneously conducting vigorous research and due diligence on those companies I now consider attractive. In other words, I am productively utilizing my time to prepare myself to intelligently invest my available cash at sound and attractive valuation. Although I am not in a hurry, I do not intend on holding my cash for an extended period of time either.
Although my ultimate goal is to be fully invested at all times, fully invested rarely means 100% invested. Dividends are continuously coming into the portfolio which I accumulate pending investment into select dividend growth investments that I consider most attractive and/or most appropriate regarding keeping my portfolios properly diversified and balanced. Perhaps some could argue that my current watchful waiting status would be considered building cash. To a certain extent that would be true, but my ultimate objective is to get this money invested as soon as possible, but only when attractive opportunities are available.
Furthermore, I contend that you make your money on the buy side. Simply put, this means only being willing to invest when valuations are, at a minimum, sound, but preferably attractive (undervalued). Therefore, applying a little watchful waiting during times like today with the market in a downward spiral is in my mind creating attractive opportunities with each passing day. The more undervalued my research candidates become, the greater will be my long-term total return from both capital appreciation and a higher current dividend yield at purchase. I believe these kinds of future valuation driven return opportunities are worth waiting a little while for, but not for too long. Once again, time in - not timing.
A Dividend Aristocrat/Champion Worth Waiting For: V.F. Corporation (VFC)
For example, I am constantly scanning the universe of Dividend Champions prepared by fellow Seeking Alpha author David Fish and/or the Dividend Aristocrats compiled by S&P looking for attractive value. The broad sector Consumer Discretionary, and subsectors Apparel and Footwear represent businesses I am light in, but would like to include for diversification purposes. However, finding attractive value in this sector or subsector is often challenging.
Nevertheless, V.F. Corporation has recently been attracting my attention. I consider this apparel and accessories company an extremely high-quality company with an S&P credit rating of A and a low debt to capital ratio of 17%. Unfortunately, for the past couple of years this company has been way outside of my valuation criteria. However, since the beginning of 2015, that is beginning to change.
When a company, even a high quality company like V.F. Corporation is trading at lofty valuations like this company has been since 2013, even the slightest hint of bad news can knock it off its high perch. V.F. Corporation remains highly profitable, and their dividend increased in December, 2015, however, this company is expected to report weak earnings for fiscal 2015. Both their 2nd and 3rd quarters of 2015 were weaker than expected, which has brought their stock down slightly more than 25% off its high established in the summer of 2015. The following earnings and price correlated F.A.S.T. Graphs™ clearly illustrates the above:
Unfortunately, I do not believe the company is attractive enough just yet to induce me to invest, but it is getting closer with each passing month. This represents one aspect of the watchful waiting process I discussed above. Since I admire this company very much, and would be delighted to include it in my portfolio if the price and dividend yield were attractive enough, I am patiently keeping my eye on the unfolding opportunity I am seeing. The company announced they will report their 4th quarter 2015 earnings and conference call on February 19, 2016. I am keenly interested in what they will report and how the market might react when they do. For those not familiar with V.F. Corporation, here is a screenshot from their website listing their brands:
Target Corp. (TGT): The Watchful Waiting May Be over
As much as I would like to invest in V.F. Corporation, I won’t wait forever or even too long. Therefore, I am continuously looking for replacement valuation opportunities. Although Target Corp. is not a perfect substitute, it is in the Consumer Discretionary sector, offers an attractive yield of 3.2%, and is currently trading at a sound valuation. Consequently, since I consider that Target’s valuation is currently sound, I am prepared to add this Dividend Aristocrat to my portfolio. However, Target has announced their earnings call for Wednesday, February 24, 2016, and I will be watchfully waiting to hear what they have to say before I do.
Summary and Conclusions
As the title of this article indicates, I believe it would be a mistake to be raising cash today. By raising cash, I mean liquidating your portfolios for fear of a market crash. It is possible, although no one knows for sure, that most of the carnage may be already over. Regardless, I do not believe it makes sense to sell into the teeth of a bear market. The time to liquidate stocks is when they are high or overvalued, not when they are becoming attractive. Over my career, I have often quipped that I am constantly living in money manager hell. I always seem to find myself euphoric at precisely the same time when my clients are in total panic, and I find myself in total panic when my clients are euphoric.
However, as I also indicated earlier, building cash is not the same as raising cash. Building cash during times of market weakness can be very profitable and productive, as long as you don’t sit on the cash too long. On the other hand, during periods of market weakness, being too anxious is not always the best course of action either. But what’s important, is that you always recognize and remember that it’s generally impossible to hit perfect market tops or market bottoms. The best we can expect to do is to be reasonable and prudent with our purchases and our sells.
Disclosure: No positions.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.