Holding cash while waiting for a fat pitch is overrated
“Investors waiting for Godot” by DALL•E
Forty thousand people descend each year on a convention centre in middle America. They're there to learn from Warren Buffett and Charlie Munger, two of finance's best minds. But the hero worship runs deep. Slapping a value investor's mother is safer than critiquing their idol. And few of Buffett's commandments get more head nods than to 'wait for a fat pitch', a baseball analogy that means an easy-to-hit ball. Buffett uses this phrase to suggest you hold cash until you find an excellent investment. The idea is intuitive and sounds sensible. But for most of us, waiting for Godot will make us poorer than we would otherwise be.
First, the opportunity cost of doing nothing is enormous. American stocks have returned 9.6% per year on average over the past century. If you had a hundred bucks and waited a year, on average, you would have had to buy something worth $110 for that same $100. In five years, it would be $158, or a 37% discount. While ten years of thumb-twiddling would have put the needed discount closer to 60%. A tall ask.
Mr Buffett, for example, has cost Berkshire's investors $136bn by waiting to invest or distribute excess cash over the last two decades. A simple policy of putting the spare money above $20bn into the S&P 500 would have left investors far better off. That's not to say Buffett won't make some incredible buys. Instead, he must buy assets worth $244bn with his $109bn of cash to make up for the loss.
The longer an investor waits, the bigger the future discount must be. Time marches on without mercy. Uninvested money burns a hole in the investor's pocket, increasing the return demanded. But that lowers the chance of finding an investment that will make the opportunity cost back. More stocks trade at a 5% discount to intrinsic value than ones at 50%. And even fewer still that will move the needle on a hundred billion.
Second, timing the market is almost impossible. JPMorgan, a bank, found that if punters put everything in the index from 1999 to 2018, they made 6% per year. But, if they missed the ten best days, that dropped to 2%. Staying in ensured they got the upticks, which were the bulk of returns.
Moreover, biases wreak havoc on our ability to time the market. Traders tend to panic sell during downturns and become overconfident during the boom. They buy high and sell low—the opposite of what they should do. The same study showed that investors got lower returns than the stocks they invested in. Their timing sucks. By waiting, investors miss out on the big upswings and do worse than the market if they try to time their buys instead.
But thumb-twiddlers argue that cash has option value. That is true if you can access deals you wouldn't otherwise be able to, most likely during a financial panic. Further, you need the ability to value and time those purchases well. And the payoff must be greater than the opportunity cost of waiting. But the evidence investors can do this is slim to none. Mr Buffett has an incredible track record. Cash in his hands had immense option value in the past. But it gets harder and harder with size.
When investors try to buy the dip instead, their returns don't improve. Since 1928, the S&P 500 has had 26 down years. Five saw a quarter of the value knocked off in a calendar year. If you bought each time the market dropped 25%, you would have made 9% per year over the following decade. That's no better than the average market return.
For the vast majority of investors, cash will have no option value. In fact, holding onto it is a negative. As Pozzo, the pompous slave owner in Samuel Beckett's play, Waiting for Godot, says, "that's how it is on this bitch of an earth."