What Investors Should Know Before Following Ray Dalio's 'Cash Is Trash' Mentality

- By Rupert Hargreaves

At the beginning of 2020, Ray Dalio (Trades, Portfolio), the founder of the world's largest hedge fund, Bridgewater Associates, proclaimed his stance that "cash is trash." Rather than owning cash, he advised, investors should hold a globally diversified portfolio of stocks.

He doubled down on this view in April. In a Reddit "ask me anything" session, Dalio stated, "I still think that cash is trash relative to other alternatives, particularly those that will retain their value or increase their value during reflationary periods."

Is cash really trash?

As he is one of the world's most successful and influential hedge fund managers, I will not claim to know more about the subject of cash and asset allocation than Dalio. However, I do not think his advice should be taken at face value.

Dalio's advice may have been suitable for some investors, but it's unlikely to be suitable for all investors. Indeed, even with cash interest rates where they are today, there's still a role for cash funds in an investment portfolio.

Warren Buffett (Trades, Portfolio)'s Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) provides us with the best case study of how cash can be used successfully in an investment strategy.

Before continuing, I think it's worthwhile to consider the investment structure of Bridgewater vs. Berkshire and what we can take away from it. For example, Bridgewater is a hedge fund. Investors who have their money with the business will have other investments elsewhere. This will undoubtedly include cash for emergencies. On the other hand, Buffett has designed his investment vehicle around a sort of savings account structure. This is just one of the reasons why he has a conservative balance sheet structure.

Berkshire also needs to reassure its counterparties at the insurance business that its balance sheet is strong enough to withstand even the most severe shocks. The best way to do this with considerable cash resources. So in many respects, Berkshire's style is more relevant for the average investor. The company needs to keep cash on hand to meet credit demands and take investment opportunities when they arrive. Bridgewater, meanwhile, does not need to worry about holding cash. If it needs more cash, it can just ask investors to put in more money.

Two 'buckets'

That's why Dalio's advice should not be taken at face value. Instead, we should view this advice as part of a larger plan. For example, every investor should only invest what they can afford, and leave money over to cover any unforeseen expenses, as well as several months of living expenses.

This will produce two financial "buckets," the savings bucket and the investing bucket (which is very similar to Berkshire's structure, although we'd also have to have private businesses to the mix).

Implementing Dalio's advice in the investment market may be the most sensible strategy in the current interest rate environment. Doing without a savings bucket to cover any unforeseen expenses, on the other hand, could be downright dangerous. It could potentially expose an investor to serious risks.

As we have seen this year, stock market crashes tend to correlate with job losses. This could mean that investors lose their regular income just as the market declines, putting unnecessary strain on their finances and possibly forcing them to sell at a loss.

That's where Dalio's advice does not make sense. Even though cash is not earning anything today, investors need to consider the opportunity cost. What is the opportunity cost and risk of not having cash at the right time? In most scenarios, the opportunity cost of having cash is probably significantly higher than missing out on market gains and being fully invested.

So yes, Dalio's advice does make sense, but only as part of a full investment strategy and asset allocation plan.

Disclosure: The author owns shares in Berkshire Hathaway.

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This article first appeared on GuruFocus.