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What cash allocation should an investor hold?
Tuesday 2 February 2016
Active investors are always on the lookout for investment opportunities. Cash and cash equivalents - especially without interest – "idle money" are a thorn in
their side. Cash is, however, far more important than you think.
On the long journey through life it is important to own cash: that is enough cash on the one hand to be able to sleep peacefully at night. On the other hand, to enable us to act independently with confidence.
This also applies to employees who have a steady job and can count on a secure annual income. These scenarios are familiar to us:
. the person, who without fear, does not need to put up with everything the employer demands,
. the person who fears to find his name on the upcoming list of layoffs,
.the person who is seriously thinking about a difficult career change in order to prepare for the future,
.the person who does not wish to be tempted by corruption,
that person will need a clearly defined cash reserve. As a rule of thumb for employees I use as a maximum level two years' of liquid reserves for the money budget which includes the rent or mortgage interest due. It would also include unavoidable fixed expenses. Extraordinary outlays, such as holidays or buying
new things are excluded from the calculation.
This reserve can be drawn on in a crisis. From my experience, a cash buffer for two years is an adequate amount. If fate deals you an unexpected blow, it may take some time before you get back on your feet. The first half of the year just flies by. To cope with this, severance payments may take some time before they are paid out. Finding a good new job through a headhunter will take time as the process cannot be hurried along. A two-year cash reserve will enable you to psychologically maintain a positive attitude. This will prove to be decisive in this battle.
For the self-employed I would increase the cash reserve to three years' worth of average annual income. That is one way to survive lousy financial years,
the sudden loss of a major customer or the lead time needed for a new business idea to become profitable and it will also help to avoid unpleasant conversations with bankers.
There is another aspect of cash and cash equivalents in financial markets. Truly unique opportunities occur during major crises. The problem, however, is that the investor has almost always no cash. This has always been the case. A merchant without an ample cash reserve cannot be relied upon.
My conclusion from many years of professional experience and activity as a value investor: No matter how tedious and boring it may be to build a cash reserve, you can only invest in stocks, funds or other things after you have set those cash reserves aside. Develop a savings plan to build up a cash reserve.
The end goal: A clean and tidy life, as my business partner Simon Rolfes always says. “Take a firm grip of the steering wheel of life”. Cash is the foundation for that.