Why are cash reserves important?
If you have read my book, The Art of Building Wealth, you will be familiar with the section about strong foundations.
My advice for everyone is always, to start paying yourself first. It may seem hard at first, especially if you seemingly don’t have a lot of left over cash at the end of your month. But, if you make just a couple of small adjustments to get started, you will find over time as your cash reserves grow, you WILL find that other opportunities emerge to add more each month to grow your reserves even more quickly.
As we have seen with the events of COVID-19, imagine if we hadn’t had the generous cash injection of our government to many of us. Imagine if you had to rely on your own cash reserves through this time. How would you have coped or even survived?
The possibility of sinking into fear and possible meltdown is a real threat if you don’t have some ‘reserves’ or a ‘cushion’ (of cash) and the economy falls flat suddenly, experience this type of disruption without government assistance or you unexpectedly have some major expenses. Your life now becomes ruled by your volatile emotions and fear.
Having cash reserves stabilizes your emotions and you will ride the storm and carry on.
Initially, it’s not about the amount, it’s about the habit of saving. Starting somewhere is better than never starting at all. You build from there.
How to Build Cash Reserves
One example is to save 10% of your income each month and at the end of 3 months accelerate your savings by another 10%. If 10% is too much right now, start with 5%. Just start somewhere!
3 months establishes a habit and 10% is about the threshold of what we can handle at a time. If you continued this, after 2 years this amount will double and double again after 4 years and so on.
If you use an automatic direct debit facility to another account, then it takes the emotion out of the ‘doing’. The money in this account is to be kept separately, and becomes your cushion. A base for your new ‘savings account’. You are now paying yourself first!
Once you have a solid cushion, (step by step process explained in my book) The Art of Building Wealth only then, is it time to invest 🙂
Cash Reserves for Investing
One of Buffett’s saying’s, is that he prefers to “buy a wonderful company at a fair price than a fair company at a wonderful price.” While it’s true that stocks tend to increase in value over time, there’s no mistaking Buffett’s preference for finding a good deal.
With COVID-19 uncertainties, U.S. equities were pushed into the fastest bear market in history. It took a meagre 17 trading sessions to hit the threshold for an official bear market. All three major indexes moved from their recent highs to at least a 20% decline.
The reason Buffett has been so overwhelmingly successful as an investor has to do with his approach to investing in bear markets.
1. Buy with the intention of holding for a long period of time
First of all, when Warren Buffett buys a stock, his intention is almost always to hold onto it for an extended period of time. The average top-10 holding for Buffett has been owned an average of 32 quarters (8 years). American Express, Coca-Cola, Wells Fargo, and Moody’s which are all top-nine holdings in Berkshire Hathaway’s portfolio in terms of market value, have been held for 31, 30, 27, and 20 respective years.
Since most high-quality businesses grow their earnings over time, Buffett simply buys and allows time to do its thing.
The role that compounding has served an important strategy to Buffett when considering growing his wealth, and that of Berkshire’s shareholders. Buffett has held Coca-Cola for so long that its annual payout of $1.64 per share equates to a 50.5% annual yield based on Berkshire’s initial cost basis of around $3.25 per share.
Even when bear markets and recessions strike, the long-term investment master plan for Buffett’s stocks often remains unchanged. For example, with Coca-Cola, it has 21 brands that have billion-dollar annual sales potential, unparalleled geographic reach, and a marketing department that knows how to engage consumers. He knows that’s a good long term investment.
2. Have cash reserves at the ready. Invest regularly.
The second thing that’s made Buffett so successful during bear markets is to invest regularly. Rather than trying to time a bottom, which he would tell you is pointless, Buffett aims to buy wonderful companies at a fair price. Whether the market is down 10% or 30% from its peak doesn’t matter to him. Snagging a great businesses at attractive valuations on a regular basis is his focus. Regardless of how well or poorly the stock market is performing.
Warren Buffett is also no stranger to having a fair amount of cash reserves on hand to strike when the iron is hot. Interestingly, as a result of not making a major acquisition in four years, Berkshire ended 2019 with a near-record amount of cash on hand ($128 billion). This has left Buffett with ample capital to buy high-quality businesses during this bear market.
3. Stick to sectors and industries you know and that interest you
Buffett generally sticks to the industries and sectors that he knows inside and out. This third factor makes Warren Buffett such a successful investor in bear markets.
Buffett’s view is, “Diversification is protection against ignorance.”
Around 87% of Buffett’s portfolio is comprised of stocks from just three sectors: financials, information technology, and consumer staples.
Focus on a few sectors of the market
Berkshire Hathaway had a massive hoard of cash reserves, roughly $128 billion at the end of 2019. You might think the last thing Buffett and his team would need to do is raise money. But that is exactly what’s happening.
Remember, Warren Buffett is focused on only a few sectors of the market. These include financials, information technology, and consumer staples.
Berkshire Hathaway’s portfolio currently holds only three healthcare companies:
DaVita: This dialysis center operator would be the only true healthcare stock Buffett has any confidence in at the moment.
Berkshire Hathawy has retained only a small holding of Johnson & Johnson: a little over 327,000 remaining shares. Interestingly, healthcare makes up roughly 1% of Buffett’s portfolio.
Buffett loves to put money to work during market crashes, and he’s never had this kind of cash hoard to work with in a bear market before.
If you need help, a copy of my book will get you started nicely in paying yourself first and the stages of investing.
After that, contact us and we will explore your options and assist you further. Thus, a ‘WHOLE’ picture will show you (and us) the most important things for you to focus on.
Remember, what you do, or don’t do, today, is what matters most.
So start paying yourself first from today.
If you have any questions regarding your current situation, please don’t hesitate to get in touch.
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Disclaimer: This article is factual information only. It is not intended to imply any recommendation about any financial product(s) or to constitute financial or tax advice. The information in the article is reliable at the time of distribution, but may not be complete or accurate in the future.