You have $100 billion in cash. How do you invest it? That may seem like a good problem to have, but it is actually more of a challenging question than you realize. It’s been reported that Warren Buffett is sitting on a pile of cash. Some people have taken this as a sign that they should move to cash. But they’re missing the more fundamental issue. It’s harder to invest $100 billion than you may think.
Warren Buffett taught his kids an important lesson. He gave them each $1 billion dollars and told them they had to donate the entirety to charity. At first, this seemed like an easy task. But they soon realized it was more complicated than they thought. One billion dollars is more than the total budget of many charities. Should they give it all to one organization or give smaller amounts to multiple organizations? How would that influence the outcome? “You get a lot of people who have big hearts but don’t have business skills,” says Trevor Neilson, president of the Global Philanthropy Group. “That leads to a lot of ineffective nonprofits1.”
The scale of Buffett’s money and influence is a challenge in investing as well as in philanthropy. His investments literally move the markets. Most of us are not Warren Buffett, though. It is unlikely that you will invest in a public company and immediately become the majority shareholder. So, should you stay in cash? Chris Creed recently sat down for an interview and answered the following questions. You can jump to his answers by clicking on the links below.
Why is Warren Buffett sitting on so much cash?
Chris: Warren Buffett is being selective for a couple reasons. Of course I’m not in his brain, but we know Warren Buffett is a value investor. So he has to be very selective. He’s going to keep his cash until he finds something that he thinks is a good value. There are certainly parts of the market that you’re going to pay a premium to own. For example, recently there was a tech selloff. You could have argued that the tech market was getting pretty hot. A lot of the large cap companies, the very large companies that he has invested in previously, those are some of the ones that are pretty expensive in his view. So as a value investor, he would have to go to mid cap or small cap companies.
What are some implications when Buffett makes a purchase?
As big as Warren Buffett is, if he buys mid- or small-sized companies, he can actually move the market. In other words, they trade lower volumes than the larger cap type companies on average. He could actually drive up the price while he was buying that just because of the amount of capital he has. I suspect he doesn’t like holding cash to the tune of $100 billion. He would rather have it invested. I’m not sure of the size of his company, but I think it’s around $400 billion. It’s a healthy amount of cash, but he’s very heavily invested in the equity market as well. So if he felt truly like he needed to be out of the market, he would just pull more money out of the market, which he hasn’t. With that said, he has to be selective about what to invest in because of his size.
The other thing that is probably somewhat intuitive is that not only does Warren actually buy the shares that potentially drive prices up, but also just talking about doing that can drive the price up. When people hear Warren Buffett is going to be taking a position, it’s going to change the stock price, possibly dramatically. If we (AFAM Capital) do it, it’s not going to move the market in most cases.
What’s the benefit of not being Warren Buffett?
Chris: We kind of act as Warren Buffett for our clients. We are selective with their cash. We keep cash on the sidelines if we need to. Our cash is probably around six percent for an average client right now, instead of the 25 percent Warren Buffett has. But we’ve also got the flexibility to go small and mid size if we need to. So his cash stores, I think, just lead back to him being a value investor. I think he’s being cautious with his funds. I don’t think that means an average investor has to keep so much in cash, though.
For our average holding, we’re going to be in the millions. We’ll be buying millions of dollars worth of a stock. Warren would be in the billions. Because for Warren, a lot of times he actually might be buying a majority in a company. So it can be vastly different. If we bought one percent of a billion dollars, we’re talking maybe ten million dollars worth of a stock. Warren’s investment probably doesn’t even start there. He’s hundreds of millions, or several tens of millions, up to several billions. So, it’s a completely different scale.
We have the ability to be more flexible, and more nimble. Largely, we can make these moves without people noticing and that affecting the market.
Why do you keep about six percent cash?
Chris: When the stocks that we own pay dividends, that money accumulates in a money market, basically a cash account. We use that money to find new opportunities. We generally stay pretty close to fully invested. The highest we’ve been in terms of cash temporarily has been somewhere around 10% in our Select Value managed account portfolio while we have 1% to 2% in cash on the low side, given the flow of dividends. So I wouldn’t read it as being significant in terms of the market necessarily. But if we haven’t found opportunities to replace, or if we haven’t found new opportunities to use that cash for, we’ll let it accumulate. We don’t have any hard and fast rules on how much we want to keep in cash. But if we find fewer opportunities, more money will accumulate in cash.
When do you put cash to work?
Chris: So to take it out of cash it has to be a better alternative than leaving cash and waiting. I guess on a smaller scale it’s what Warren Buffett does, although he’s got a much bigger percentage in cash than we do. But we also have the flexibility to invest in small and mid cap companies if we need to. You don’t buy stock just because you have cash; you buy bargains when they’re available. Our mantra is patience, selection and diversification. Selection means we’re not going to force the stock into the portfolio just because we like it. It has to meet scoring metrics that we’ve found predictive of future values.
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