PARKING CASH WHILE I WAIT TO BUY

Over the past two weeks I continued to build “a sound intellectual framework for making decisions”¹ by reading chapters two & three of The Intelligent Investor. Chapter two, specifically, was a bit of a doozy and covered a topic that has certainly added a layer of complexity to my decision making process, that topic being inflation. Chapter three reinforced a concept that I am no stranger to by walking through A Century of Stock-Market History culminating in the simple reality that:

“The only certainty you can derive from past financial data is that the future is always surprising.”²

When it comes to inflation, I’ll be the first to admit, it’s not something I really thought about actively protecting against. That was probably a bit shortsighted on my part. To me it always seemed like inflation was something that just happened in the background and not something to account for on a consistent basis. Knowing I should be accounting for inflation in my investment approach is only half the battle. The other half is choosing an asset class or combination of them that provides sufficient protection.

Graham briefly mentions in chapter one that an investor’s portfolio should be a mixture of stocks and bonds. Be it 75% stocks and 25% bonds, vice versa or some other division of the two. Clearly he has an opinion about which asset classes offer the best protection against the rising cost of living. Truthfully, I looked to the chapter’s commentary by Jason Zweig for a more up to date outlook on whether or not stocks and bonds are still the preferred method over commodities, real estate, and crypto. He said the following about the latter two.

Real estate:

“Real estate is shelter - although it might not shelter you from inflation as well as you think. Between 1890 and 2014, the average growth rate of U.S. home prices was 0.3% annually after inflation […] And commercial real estate is so sensitive to rising interest rates that it only partially protects against inflation.”

Crypto (Bitcoin specifically):

“You can’t draw sweeping conclusions from returns over such a short history, especially because inflation was so low over most of that period.” (Bitcoin begin trading publicly in July 2010.)

Neither of these statements are very encouraging. Comparatively the example below illustrates the differences between commodities, stocks and bonds in the second chapter’s commentary.

“Had you invested $1,000 in gold on January 1, 1900, you’d have finished 2022 with about $2,500 - compared with roughly $7,800 in U.S. bonds and more than $2 million in stocks if you’d put the same $1,000 in each.”

Armed with this knowledge I can see why Graham prefers stocks, considering they “have historically far outpaced the rise in consumer prices.”³ Both gold and real estate to me seem like they serve as a solid way to sustain purchasing power over the long run. Gold, however, in the short run is “an unreliable way to hedge against inflation.”⁴ Real estate, to my knowledge, is not the most liquid asset and, well, I am no expert, I suspect that could pose a number of problems depending on the circumstances. Additionally, “the returns on individual commodities vary wildly overtime.”⁵ Crypto, during its short history, appears to be in a similar boat. The only thing left is bonds.

Not to state the obvious, but if there’s one thing that has become extremely apparent to me it’s this: neither real estate, commodities, crypto nor bonds appear to have the ability to far outpace the rise in consumer prices in the way stocks do. If this is the case, what makes bonds the best of the rest? For me bonds would need to address a few major concerns that the other asset classes listed here don’t. They would need to be more liquid than real estate, they would need to keep up with inflation and they would need to do so both over the short and long term. Based on my own personal research and what I’ve gathered from this book thus far bonds do in fact address all of those concerns.

Instead of diving into all of the different types of bonds available such as corporate, municipal and government, I’d like to focus on how I plan to implement bonds into my own investment approach and why I feel this approach addresses the concerns mentioned above. Before I get there, however, I want to broaden the scope a bit.

My goal as I stated previously is to build a permanent capital holding company (PCHC). In a nutshell I want to acquire great businesses and use the cash flow from those businesses to fund future acquisitions and invest in public equities. In the previous issue I mentioned that I am an enterprising investor, I am looking to not only purchase great businesses but I want to do so at fair prices or at prices that are below intrinsic value. Realistically, it is unlikely that I will have an opportunity to buy a great business at a great price whenever I want to, which could potentially leave me sitting on a pile of cash while I wait for an excellent opportunity to present itself. I find myself in a similar position now, as I have stopped allocating capital until I can conduct thorough analysis that “promises safety of principal and an adequate return.”⁶ This to me is where bonds, specifically t-bills, come into play.

I see t-bills as a safe place to put idle cash making it easily accessible, while also protecting my purchasing power for as long or as short as I need to. Transparently, at the time of this writing I have not placed my uninvested capital into t-bills, but it is something I am in the process of implementing. I believe this approach allows me to protect against inflation in more ways than one. I use bonds to maintain purchasing power when waiting for an ideal investment or in my current case learning to analyze said opportunities. I use stocks to outpace the increase in the cost of living. I also use my education in innovation and entrepreneurship, aka human capital, to own and operate businesses. As chapter three reiterated, there is no telling what the future will bring. Regardless of what transpires going forward, I like to think that my approach will position me nicely to weather almost any financial storm. As Jason Zweig wrote in the commentary of chapter three:

“Instead of trying to build a portfolio that would thrive if what you think will happen does happen, strive to build a portfolio that should thrive no matter what happens.”

I believe I am now one step closer to doing just that, thanks for reading!

- Eric Seel