The Covid-19 outbreak is rapidly evolving into a economic downturn or even depression.
Cash needed
Schools, stores, offices and borders are all closing. People are being encouraged to stay at home and sales are slow. Real-estate brokers are canceling home showings. Business owners fail to anticipate a cash shortage and run out of money, forcing them to suspend or cease operations, even though they have active customers. Investors are selling everything from stocks to bonds to gold in order to raise cash. Cash is king — and this is even more so during the infectious diseases outbreak.
Cash needed x2
Meanwhile, there are some opportunistic investors looking to take advantage of this — they are looking for companies that have strong balance sheets, low volatility, stable cash flows and carrying a respectable dividend yield. And all they want is cash, more cash than they actually have, to buy as many stocks as they can.
Cash needed x3
Investor Bill Miller, chairman and chief investment officer of Miller Value Partners, described this as “an exceptional buying opportunity”. “There have been four great buying opportunities in my adult lifetime. The first was in 1973 and ’74, the second was in 1982, the third was in 1987 and the fourth was in 2008 and 2009. And this is the fifth one,” Miller said. What you need, is cash reserve to grab this best-buying opportunity.
Cash reserve vs emergency fund
The cash reserve should not be mixed with the emergency fund.
We should have at least 6–12 months’ expenses as our emergency fund. These fund should not be invested — they should simply sit at the bank account for 100% liquidity (i.e. we can take it out anytime we need). In other words, emergency fund is non-investable fund.
Cash reserve is investable but in case there is any incidents or crisis, we can use the cash reserve for:
serves as buffet and adds to the bottom-line
lowering the leverage to a safer and more conservative level
take opportunity to invest in stocks, bonds, or ETF priced at a discount
pay interest or other miscellaneous expenses so that we do not need to sell our investments when the market crashes to liquidate our portfolio and can afford to wait until it recovers
So how much cash you should reserve?
The ideal ratio is 25% of your total investment portfolio for the cash reserve.
For example, if you have $70,000 in stocks and $30,000 in bonds (i.e. total investment of say $100,000), than you should keep a cash reserve of at least $25,000.
The reason for 25% is that:
say if you take 1:1 leverage, which means you borrow to buy 50% of your portfolio, when the market is down 30% and the brokerage requires you to add capital to keep the leverage ratio, you can easily that (15%) with your cash reserve.
if you take 1:1 leverage, and the market is down 50%), you can still save your portfolio with that 25% cash reserve without having to liquidate and sell part of your portfolio at half its original value.
If you do not use leverage, you can use this cash reserve to buy more stocks to add to your portfolio and this way, you dilute your current (and temporary) loss by 25%.
Of course, if you have a strong financial status, or if you are more conservative, you can always reserve more cash in anticipation of financial crisis which occurs every 7–8 years.
Note: this is not investment advice. Please be reminded to do your own research and consider your own circumstances before making any financial decisions.
