As I spend a portion of my day digging through some of the history of programs and credits that were passed during the great recession, I am starting to get a little… fascinated by the response governments take in confronting economic downturns. Whether is was a 100% exclusion from ordinary taxes on Qualified Small Business Stock bought after 2010, or the passing of the Tax Credit Assistance Program, the people who maintain liquidity are put in a strong position for making money in a recession. The more I look at how the best value investors such as Warren Buffett, Charlie Munger, and Walter Schloss managed their portfolios by keeping large amounts of cash available to them, the more I start to think that strategy should be replicated by even mom and pop investors.
Liquidity is Key to Making Money in a Recession
One of the lessons constantly harped on in finance circles is the importance of liquidity. You can’t go anywhere without hearing, “keep 6 months pay in the bank.” While I personally think that’s a lower level than you should have, that concept should be etched in your mind. That money will allow you to sleep at night without worrying. The reason why I think that’s lower than what it should be is that it limits your ability for making money in a recession.
Read the annual report of Berkshire Hathaway, and a number that jumps out is the $90 BILLION cash horde that Warren Buffett has accumulated at Berkshire Hathaway. That money is the dry powder that can fuel hundreds of billions of dollars in future wealth for shareholders. When the great recession occurred, and Berkshire was one of the few places that could bail out institutions, Warren Buffett was able to turn a downturn in the stock market into a mint for shareholders. Examine the deals for preferred shares, businesses bought, and the shares of publicly traded corporations now on the balance sheet. Those businesses are going to send Berkshire billions of dollars that will enrich shareholders for decades.
What you can use Liquidity for:
While it’s fine and dandy to examine a billionaire’s actions during a recession, there are naturally some… difficulties in translating that to a family making $50,000 a year. That is where you have to be creative. You have to use the tools that are at your disposal like Roth IRAs and government programs.
Look at the shares of Wells Fargo that were bought at $8.00 a share during the great recession. Those same shares are now worth $52. On top of that Wells Fargo pays a dividend of over $1.50 a share. If you had $8,000 saved back in 2008, you could have bought a thousand shares. Over the next nine years your position would have grown to over $52,000 paying you over $1,500 dollars a year. Had you saved that money in a Roth IRA, and reinvested the dividends, your wealth now would be a lot higher. By saving a reasonable amount of money for a great buying opportunity, you can fund your retirement on Wells Fargo. Had you been 30 years old when you first bought those shares, you would now be 39 with an IRA worth $52,000. If those shares with dividends reinvested compound at 10% annually, when you turn 67, you would have a fortune worth almost $750,000!
The Level Of Liquidity I think you Should have
In order for anyone to have a shot at making money in a recession, I think you should have about fifteen to twenty percent of your assets in cash or short term US treasury bonds. Once you get to a reasonable amount of money in the bank, you need a portion of your savings not only for an emergency, but also for taking advantage of opportunities that life may throw at you. While I worry that a lot of people reading this may think that what I am saying is you should invest all your money once the stock market falls X amount, that is NOT what I am saying. Make sure you have the savings for an emergency, and then build your reserve for buying stocks, apartment buildings or bonds. Don’t throw away a good nights sleep and financial health when things go south for a chance at more money… that’s a terrible trade.