Should You Be Fully Invested?
Board: Berkshire Hathaway
What are people's thoughts on the general concept of being fully invested when you can find stocks that meet your minimum return requirements? If an investor truly has, for example, a 10% hurdle, it is foolish to me to be sitting in tons of cash now as I believe there are plenty of stocks to meet that return requirement, when managed as a portfolio, and impossible to consistently time the market.
Bear in mind that a lot of people in the investment management industry have a very high motivation to advocate being fully invested. So, beware the "expert", but especially beware the expert who is not disinterested. It's interesting to note that Berkshire has quite a lot of cash, for example.
I like to be fully invested because I'm greedy, and I like to have a pile of cash because it's so darned handy when great opportunity comes up. I squared that circle by selling some stock, buying in the money calls, and leaving the cash I raised sitting there. The calls control the upside on somewhat more stock than I sold, so in one sense I'm now long with leverage. In another sense my portfolio has a 1/3 cash allocation. Perhaps this is the worst of both worlds, I dunno. It does have the advantage of not having to answer the tough question you post.
I think the best answer is to assess the return between now and (say) eight years from now on your cash. The more sure you are that at least some good things will be very much cheaper at some point between now and then, the more certain it is that the cash allocation will pay off. This requires knowing yourself well enough to know that you will be able to act the next time things look really scary. Consider: the market could be flat for 6 years, fall by half in 1 year, then rebound to where it is now. Sitting on cash till somewhere in the vicinity of that market bottom will have a great 8 year return. (9.1%/year compounded, plus 6 years of interest and 2 years of dividends)
One can't be very sure at all about what the market will do or when, but it's not so hard to come up with a "good enough" estimate of how overvalued it is and the consequent likely spread of outcomes in the next several years based on the valuation of the typical firm. The longer it is till the next bear, and the shallower it is, the higher the opportunity cost on cash. But imagine this conversation having happened in 2007. Foregone profits are not the same as losses. For the broad market I think that being fully invested made sense in Q1 2009, but not now. For some very specific names? It will take an intellectual outlook beyond the next bull/bear cycle—basically being happy to ignore a bear—for it to make sense.