Some Cash

Why We Always Hold Some Cash in Our Portfolio

Each week all of us at Investing Track read a book about investing or business. We read Jim Collin’s Great By Choice last week, which illustrates why certain companies thrive during uncertain times while others don’t.

Listed below are two points from this book that apply to investors and businessmen.

Always Have a Safety Net (aka Cash Reserves)

It’s not possible to predict the unpredictable. Since nobody has a crystal ball, life will throw sucker-punches at you.

When your portfolio is hit by a big correction that you did not foresee or your business faces an unexpected crisis, you can do 1 of 2 things.

  1. Complain about how unfair the world is. “Why am I always so unlucky?”
  2. Recognize that no one can predict the future and create buffers to protect yourself against uncertainty.

You can prepare for the unpredictable even though you can’t predict the unpredictable. Successful investors and businesses survive major crises because they always create multiple buffers to lean back on during dangerous times.

For example, our firm always holds at least 10% cash, even when we are certain that a massive rally is about to begin. Our model has never failed to predict a bear market and we’ve only failed to predict 2 big corrections since 1950 (the year our data begins). Thus, our confidence in our model is pretty high.

However, there is a saying that goes “there are old investors and there are bold investors, but there are no old and bold investors”. With investment experience comes appreciation for the fact that no one can predict bear markets with 100% accuracy even if he/she had a 100% historical success rate.

So even though our model has never failed to accurately predict a bear market, perhaps the day will come when our model does fail. Although we continue to research ways to improve our model, we must always prepare for the worst case scenario.

Why must we avoid every bear market?

Our model yields an average return of 30-40% per annum. It can do this because our firm holds UPRO (3x leveraged ETF for the S&P 500) when we are bullish on the U.S. stock market. A 3x leveraged ETF like UPRO will lose 90%+ of its value in a bear market. This means that if we fail to predict a bear market, our portfolio will decline 90%+.

That’s why we always have at least 10% cash. We will put all of that 10% cash into UPRO if our model fails to predict a 40%+ decline in the S&P 500. The market always rallies furiously when the bear market is over. With 10% of our portfolio still intact and whatever is left of our decimated UPRO position, we will make back a significant part of our loss in 1-2 years.

We’d once again like to reiterate that such a complete failure on our model’s part has never occurred. But you never know. Be humble and recognize that there is no such thing as a Grand Master of the markets. Holding 10% cash during bull markets will decrease our returns by 10%. But this cash reserve is a lifeline.

The same concept applies to business. All businesses should hold cash reserves. Ford was the only U.S. automaker to emerge from the Great Recession relatively unscathed. Ford’s CFO predicted the possibility of a recession all the way back in 2006. Thus, Ford borrowed billions of dollars in case such an event occurred. With 20/20 hindsight, it proved to be a prescient move.

A cash buffer will cause your ROI to suffer when the economy is growing. Afterall, that cash buffer isn’t being utilized to its fullest short term potential. However, a buffer will help you live to fight another day when the economy deteriorates. Many companies go bankrupt during recessions merely because they have no cash left. It doesn’t matter how high your business’ average growth rate is. Once you’re dead, you’re dead. There can be no come back.

Do Not Overextend Yourself

This interesting idea is similar to the adage “slow and steady wins the race”. This idea applies differently to investors and businesses.


Conventional wisdom states that you should cut your position size during losing streaks and that increase your position size during winning streaks. This rule of thumb may apply to discretionary traders since the psychological factor is important to trading. However, it does not apply to quantitative investment firms such as ours since we’ve eliminate the psychological factor.

Our investment strategy turns this idea on its head. We think it’s better to increase your position size during losing streaks and decrease your position size during winning streaks. The the market rises incessantly and you’re making money hand over fist, the market will probably reverse. When the market falls incessantly and you’re losing your shirt, the market will probably reverse. Good patches follow bad patches, and vice versa.


X% a year of consistent growth is better than massive swings in growth. Your business might go bankrupt if it overextends its resources before an inevitable recession comes along.

This means that sometimes you’ll need to purposely limit your growth, especially when the times are good and your industry is hot. Like Abraham Lincoln said “I may walk slowly, but I never walk backwards”.

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