(Source: www.straitstimes.com)

Most people would agree that it is important to keep some cash on hand for an emergency or unexpected situation.

But one thorny question is just how much cash to keep available, given that depositing it in the bank gives us next to zero returns with interest rates still extremely low.

If you ask a financial adviser, the chances are that he would advise you to keep at least six months’ worth of expenses on hand in case you lose your job or need the money for an unexpected purpose.

He is also likely to suggest that you should work the rest of your money as hard as possible and throw it into blue-chip stocks, stock index funds, insurance investment-linked products, other securities or anything offering a better return, since cash earns you nothing.

It seems like a reasonable argument, but this is not the trait I have observed among the shrewd investors I have met in the course of my career.

Instead, they share a trait often seen in my parents’ generation: They hoard large amounts of cash, often because they know from first-hand experience that terrible things can happen from time to time – often without warning.

One elderly businessman I know keeps an eye-popping $20 million in the bank. He very rarely touches this money. Even when he needs money to tide over a temporary cash-flow problem in his business, he would take out a loan whose interest cost is much higher than what the bank pays him for his deposit. He also makes sure that he settles the loan as quickly as possible.

More interestingly, while he is extremely careful with this pot of cash which he calls his “coffin money”, he sometimes takes enormous risks in his investments and business ventures with his other sources of money.

To the rest of us, this strategy might seem a little strange – to be extremely cautious with his nest egg while taking big risks with his business, but I find there is a certain logic to recommend this approach.

Even if you have to tie up much of your money in a risky business venture or investment, you must ensure part of your retirement nest egg is invested in a cautious manner to ring-fence it against risks linked to your business or investments.

If you think that only rich Asians adopt this strategy, you may be surprised that plenty of wealthy people in the United States take to the same path as well.

The most famous, of course, is the legendary financial guru Warren Buffett, whose company, Berkshire Hathaway, sits pretty on a war chest of US$70 billion (S$94 billion) as at the end of last year.

His partner, fellow billionaire Charlie Munger, reputedly advised investors: “There are worse situations than drowning in cash and sitting, sitting, sitting. I remember when I wasn’t awash in cash – and I don’t want to go back.

And they are hardly outliers in that sense. A study of nearly two million households with investment portfolios of US$3 million or more in 2015 by United States Trust Company, one of oldest trustee companies in the US, showed that eight of every 100 respondents held at least 50 per cent of their portfolios in cash. A further 14 in 100 had at least 25 per cent in cash, while another 40 out of 100 held between 10 and 24 per cent of their portfolios in cash.

Why is holding so much cash useful to them? One good reason I can think of is the precipitous drop in stock prices worldwide in the wake of the failure of US investment bank Lehman Brothers in late 2008.

In Singapore, the resulting fallout caused share prices of blue-chips such as DBS Group Holdings, OCBC Bank and United Overseas Bank to fall to their lowest levels since the Sars crisis six years earlier.

For most people, the absolute minimum level of cash they should aim to hold is that emergency fund mentioned earlier, covering at least six months of expenses to get through unexpected disasters without having to sell off their assets or incur credit card debts. Beyond that, I find that most prudent investors aim to keep at least 10 to 20 per cent of their net worth in cash.

This should have provided investors with a wonderful buying opportunity, but many of them were unable to capitalise on it because they didn’t have much cash on hand and borrowing from a bank was nigh on impossible because of their other loan commitments.

The biggest beneficiaries included billionaires such as Mr Buffett, who snapped up big stakes in blue-blooded US firms such as Goldman Sachs and General Electric, making billions as their share prices subsequently recovered.

Mr Buffett was a high profile investor to win big during that dire period, but I have a doctor friend who also did well back then. He took the opportunity to snap up a terrace house as the private residential market was rocked by the global financial crisis.

As he had hardly invested in anything and had a frugal lifestyle, he was sitting on a tidy pile of cash. This enabled him to close the purchase quickly. Thus, even though his cash didn’t seem to be doing anything for him over a long stretch of time, it came in handy just when he needed it.

Mr Buffett used to say that having ready cash is like oxygen; everyone needs it and takes it for granted when it is abundant, but in an emergency, it is the only thing that matters.

I took his advice to heart when I finally got around to taking a hard look at the adjustments I had to make to my nest egg last year when I hit 55 – the age many would consider to be the threshold of the autumn of their lives.

Apart from topping up my newly-created Central Provident Fund (CPF) Retirement Account by $80,500 to make it up to the enhanced retirement sum of $241,500, I had planned to set aside sufficient cash to ensure that I would have enough to cover my bills without having to tap my other sources of funds or sell my equity investments under duress when I wouldn’t be able to get a good price for them.

But holding cash can be very painful financially since it earns me virtually nothing.

That was when I discovered that I could put money into my CPF Ordinary Account by making a partial or full refund of the CPF savings which I had withdrawn to buy my home, as well as the accrued interest on the withdrawn sum, even though I haven’t sold the property.

True, monies placed in the CPF Ordinary Account enjoy only 2.5 per cent interest, but that is still double the rate I get on my six-month fixed deposit. What is more, since I am past 55, I enjoy the flexibility of being able to withdraw it at short notice if I ever find a need to.

While many people may not find a 2.5 per cent return attractive, I believe this is good enough for the funds I am keeping for a rainy day where earning a return is secondary.

Better still, the cash kept in the CPF Ordinary Account is risk-free and I can sleep easy knowing that both my principal and interest payments are safe.

This is unlike some of the riskier investments I have encountered such as perpetuals – a bond-like instrument. No doubt, some of them offer yields as high as 5 or 6 per cent, but the catch is that their issuers reserve the discretion of withdrawing interest payments – and there have been instances of that happening.

For most people, the absolute minimum level of cash they should aim to hold is that emergency fund mentioned earlier, covering at least six months of expenses to get through unexpected disasters without having to sell off their assets or incur credit card debts. Beyond that, I find that most prudent investors aim to keep at least 10 to 20 per cent of their net worth in cash.

I know that it feels wrong to be sitting in cash and earning nothing. But even a slightly negative return after inflation beats the hell out of losing 10 to 20 per cent of your capital on an investment gone sour.

As Mr Munger once said: “It takes character to sit there with all that cash and do nothing. But I didn’t get to where I am by going after mediocre opportunities.”

More Info: www.straitstimes.com

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