Lesson 5 of 7
Cash as a position
Cash is a position with its own return and its own job, letting you act when something meets your standard.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- Cash is a position, not the absence of one. It earns the short-term interest rate, which is often below what businesses earn, and it does one job: it lets you act.
- Holding a share of the portfolio in cash costs you the average return you gave up, weighted by that share.
- What cash gives up in a rising market it can return in a falling one, if it lets you buy when the process finds something meeting the standard.
Cash is a position like any other, chosen instead of one that could have been made. It earns the short-term rate, which rises and falls with interest rates, and its return is the price of the one thing it buys: the ability to act without first having to sell something else.
What holding cash costs when the rest of the portfolio earns 7 percent
- 0% in cash7.0%
- 10% in cash6.3%
- 20% in cash5.6%
Cash is not nothing
Klarman argues in Margin of Safety that holding cash is itself a position, an active choice against staying fully invested, not a default a portfolio falls into between decisions. Treated that way, the question is not whether to hold cash, but how much its cost is worth paying for what it buys.
What it costs
In this example cash earns zero, to keep the arithmetic plain; a real cash rate narrows the gap. Even so, cash pulls down the average return in direct proportion to its share of the portfolio. Holding a fifth of a portfolio in cash, when the rest returns 7 percent, gives a blended return of 5.6 percent that year: 0.8 times 7. Left in cash over many years, that gap also loses ground to inflation, since a dollar held as cash buys a little less each year that prices rise.
What it buys
The cost is only half the arithmetic. Cash is the part of a portfolio that can act immediately when the process finds a business that meets its standard, without first selling another holding into a price you did not choose. Capital already committed elsewhere cannot do that. Its cost is paid every year. It is earned back only if a price that meets the standard appears, and nothing guarantees one will.
Check yourself
A portfolio holds 20 percent in cash, earning zero, and the rest earns 7 percent. What is the blended return?
- 7.0%
- 5.6%
- 1.4%
Show the answer
Answer: B.
0.8, the 80 percent not in cash, times 7 percent is 5.6 percent. The cash share pulls the return down in direct proportion to its size.What does Klarman argue cash is, in a portfolio?
- An absence of a decision
- A position, chosen deliberately, with its own role
- Always the wrong choice to hold
Show the answer
Answer: B.
Klarman treats holding cash as an active position rather than a default, one whose cost and purpose can both be named.What does cash buy, according to this lesson?
- A guaranteed higher return
- The ability to act when something meets the process's standard, without selling elsewhere first
- Full protection from inflation
Show the answer
Answer: B.
Cash lets you act without disturbing another holding. It does not raise returns on its own, and it loses ground to inflation over time rather than protecting against it.Sources
- Klarman, Margin of Safety, 1991, on holding cash as a deliberate position rather than a default.
What this leaves out
- The 7 percent return and the zero return on cash are round, invented inputs for the arithmetic, not a forecast for either.
- Real cash rarely earns exactly zero. Short-term instruments pay a rate that moves with interest rates, and this lesson does not size that rate.
- Inflation reduces the real value of cash held over time. This lesson states that cost without measuring it.
- Nothing here says how much cash any reader should hold. It is not advice about any security.