“Market forecasters will fill your ear but will never fill your wallet.” These are the words of Charlie Munger and Warren Buffett which make so much sense. Human being has not lived such worrisome life what they are today is the general consensus of public. There is not a single day where I have met someone who doesn’t stop expressing some concern over BREXIT, asset prices inflated due to intervention of central banks across the world, China collapsing, will it rain enough this year, will inflation be under control when new governor comes in RBI and many more.

But in reality, there has always been a time with an equally worrying frequency of concerns. Consider investors in 1980’s, early 90’s, 2000’s and in 2007 and so on. All of those events have proven that stock market is the riskiest asset class to invest in. in fact, cash is riskier.

Cash seems safe but it erodes purchasing power

If you ask your parents or grandparents they will tell you that cash is the safest option. I won’t blame them for their views as at those time there was no transparency in the stock market and bank deposits were fetching 15% interest per anum. But cash returns currently guarantee your purchasing power will be eroded the longer you stay invested in cash. It is as certain as the sun rising in the east tomorrow.

Check out the top 200 rich list. How many decades did many of those entrant take to achieve their ‘wealthy status? How many black swan events hit the economy and the markets in that time? And how many of them listed ‘cash’ under the heading, source of wealth?

Of course majority of investors in the stock market does not think of their portfolio as a selection of stakes in the operating businesses. They instead think of their portfolio as bunch of wiggles that go up and down with every latest fad and fear. To them, risk is in the volatility in the share price. But if the temporary movement in the share prices is compared with permanent erosion of purchasing power from holding cash, should we not be endeavouring to hold little cash in our portfolio?

The answer is yes. Our aim should be to fully invest in the asset that produce the highest returns in the long run.

What if equities are expensive?

Well, this is what we think today that equities are not attractive to buy. Share prices should be so much attractive that even a mediocre performance from the underlying business should produce the attractive returns.

And after looking at the current interest rates in the bank for cash will not even cover the real inflation, so too will be the over payment for stocks and property.

So if the stock market is overpriced then your attention should turn towards the immediate probability or risk to capital destruction. Stock market has the highest probability where you can destroy your capital most. Let us look into the past, do you remember those days when the interest rates were 15% and the real rate 5% (after adjusting the inflation). Those high rates ensured companies were careful with their capital allocation and many of us were talking about long decline in the interest rates in the coming future. The debt was too low and Indian indices were trading at price to earnings ratio of 18X and your investment returns were almost 25% per anum.

Today, we have almost mirror opposite image. Debt is almost double and banks are facing issues like NPA’s and need more capital to strengthen their balance sheet. Company profit margins are declining, productivity is falling down and interest rate cannot fall much further, and in our opinion there is a good chance of interest rates to rise. The earnings are growing at lower band and companies are distributing most of their profits back to shareholder. Which suggest that we will see lacklustre growth in the coming future too. And still today investors are paying 22 times P/E ratio to buy them. How can this be attractive time to invest? It cannot.

The current market justifies a cash holding

Holding some cash sounds prudent when no one else has it. Cash to a business is like oxygen to body, Warren Buffett once said, “Never thought about it when it is present, the only thing in mind when it is absent.”

Prem Watsa, India’s Warren Buffett recently noted;

“Cash gives you options, gives you the ability to take advantage of opportunity but you have to be long-term. The cash gives us a huge advantage in terms of taking advantage of opportunity as and when they come. At the moment, we don’t think they’re many, so we are building cash.”

Cash provides us opportunity when markets falls, though it is a terrible long term investment. In such time, we should consider cash as a call option over future cheap share price and no expiration. Cash is guaranteed to avoid one risk – the risk of permanent capital loss. But same time it is also guaranteed to adopt another risk – the loss of purchasing power. Having all of your assets in cash makes no sense.

Remember Warren Buffett once mentioned that fund managers are playing a baseball game where the investors are yelling to them, “don’t just sit there, swing at something!” private investors like you and me are not playing the game where we have to listen: we can sit here and wait for the perfect pitch.

In the long run, share prices will always follow the performance of underlying business. In the short run, the share price will bear no resemblance to business performance. that is why Ben Graham, the father of value investing, noted that in the short run the market is ‘voting machine’ but in the long run it is ‘weighing machine’.

If we all are on the same page, then, investing in the stock market for week, month or even for a quarter is risky. Then holding cash for the short term must be safe. When you are investing in the stock market for multi decades than daily share prices are meaningless and being invested fully should be your goal. Building a diversified portfolio over a period should be the process.

And there is your answer. You are buying overtime. In meantime, hold some cash. Don’t hold all of your assets in cash, which is not sensible.

Today market is holding three aces and to avoid any permanent capital loss, cash holding is the smart strategy.

Aziz Dodhiya is the chief investment officer for the Valueoperations funds which operates in the Indian market as an FPI (Foreign Portfolio Investor). We do not offer any personal advice to buy or sell any stocks and the views that are shared by Aziz might not incline to your personal investment strategy and this is the reason we advise you to take professional advice before going ahead with our views.