I have a hot investment tip for you. It pays no dividends, earns next to no interest and won't go up in value. In fact, long term, it will only lose value. But you should always have a lot of your savings in it.
I'm speaking, of course, of cash: readily available, liquid dollars. Ensconced in a bank account, cash might earn a fraction of a percentage point, meaning, after inflation, that its value only falls.
So why would you want to hold cash? Because by doing so you'd be doing what all the great investors do: preparing for a rainy day.
I don't mean a crack in your foundation or an emergency airlift off a mountain somewhere, although those could be good reasons to have some cash at hand.
I mean a rainy day in the markets – any market. Let me give you an example.
If you kept, say, 30 per cent of your savings in cash at most times, you'd have had a lot of money ("a lot" being relative to your net worth rather than in absolute terms) to put to work when the market hit bottom in March of 2009.
The broad market dropped to about 8,000 points at that low point. Notwithstanding the year-to-date poor performance, it's up almost 60 per cent since then, in a little more than two years. And you wouldn't have had to pick a stock or a handful of them. Just buy the index. (Had you picked the more volatile shares you'd be up much more.)
Most of us lost a lot when the market swooned – the market peaked at 15,000. To give a simple example of the math, had you invested all of your money in the index in July of 2005, the value of your shares would have gone up by about 50 per cent by the time stocks peaked. Today you'd be up about 30 per cent, all else being equal.
But had you kept a third of your money in cash and then invested it at the low, you'd be up about 40 per cent, a significant improvement.
Of course, this assumes that you'd have known to put all your cash to work in March of 2009, which, for many investors, might be a stretch (although training yourself to be fearful when others are greedy and greedy when others are fearful, to paraphrase Warren Buffett, is probably the best education you can gain as an investor). But I'm trying to make a point: We hear an awful lot about staying "fully invested" by the investment industry, and of course they would say that. We all do what our incentives dictate.
But it just doesn't make sense. For example, one of the reasons stock prices can plummet so fast is margin calls. Some investors borrow money to invest, and as stocks start to fall, their brokers will call them and make them top up their cash or margin, the collateral for the loans they use to buy stocks. This accelerates the fall in stocks because those with no money, or too afraid to put more money in, liquidate falling stocks to eliminate the margin requirement.
Given the lack of buyers when these forced liquidations occur, it's easy to see how a stock index can be cut in half so quickly, as they were two-and-a-half years ago. Were stocks really suddenly worth only half as much? Of course not. It was a glorious buying opportunity and to have cash when others don't is a tremendous advantage.
When stocks are going up it's always tempting to throw more money at them, especially when encouraged to do so by the powerful marketing machine that is Bay Street. Resist.
We live in interesting times. Volatility is probably going to be with us for a while, which can make stocks cheap for brief periods of time. Be ready and be liquid. That's how you get an edge.
Fabrice Taylor publishes The President's Club investment newsletter, focusing on off-the-radar small to mid-cap companies trading at a discount to net asset value. He can be reached at fabrice.taylor@gmail.com.