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October 07 newsletter

Cash is king. Apart from those times when a country suffers a period of hyper-inflation, as Zimbabwe does today or as Germany did in the early 1920s, cash is king (as part of a diversified portfolio, hoard some gold coins to help the family emigrate to a new country).

Why cash is king

Until you sell an investment, the value is only nominal. According to the stock exchange, your share portfolio may be worth $10,000 at the close of business. According to your latest local government ratings advice, your rental property may be worth $430,000. But they are only nominal values.

What happens if there is a major share crash overnight? What happens to residential property prices if one of New Zealander’s major trading partners suffers a currency meltdown, reducing the number of immigrants to this country?

Don’t count your money chickens until they have hatched.

Cash and share values

It’s also a useful lesson to remember that cash is king when considering investing opportunities. If assessing the prospective value of a company’s share, a telecommunication company for example, you will be bombarded with industry metrics and statistics, such as new connections and capital expenditure requirements. What you really want to understand is the cash flow implications of those numbers. For example, a higher level of newer connections may be great, but the company may have spent a bomb on marketing trying to win that market share. So, while the company is trying to talk up the share price with higher connection numbers, perhaps the net cash flow has actually reduced. The longer-term implication of reducing cash flow is a falling share price.

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Lucky those share markets only crash once every 20 years.