A common question newer investors wonder as they start to get their hands dirty: How big of a War Chest should I build before I enter the market?
The War Chest of a company in the corporate world is no different from the individual investors’.
For a company, it could either refer to the cash reserves set aside to take advantage of unexpected opportunity (e.g. acquisitions of other companies or businesses) or crisis (e.g. buffer against adverse events).
Be Greedy when everyone else is Fearful and be Fearful when everyone is Greedy
For a investor, it largely refers to cash reserves built up for opportune use in a bear market or crash. During such times, prices get lower and investment instruments become undervalued. In other words, investors who pounced during these times not only lower their average cost of acquisitions, but also pose themselves for maximum gain during market boom. In other words, the employment of Maximum Pessimism strategy.
A bigger War Chest does not necessarily mean a better War Chest
Sure, a bigger War Chest means more firepower. Though, one that has swelled up too much could also be inefficient capital deployment.
A company, which is unable to deploy its excess cash balances beyond its normal operating requirement efficiently for a long period of time, may consider partial distribution of its cash holdings via special dividend distribution, a share buyback, an increase in regular dividend or even a combination of the above back to shareholders.
The same goes for an investor. Some continue to hoard cash in expectation of a market crash. Having a large cash reserve is not bad. However, a balance has to be made between efficient deployment and anticipatory deployment. A cash hoarder is missing out on potential capital appreciation and dividend gains over the same period of time. For the average investor, time in the market beats timing the market hands down.
Common mistake of a cash hoarder
A War Chest, contrary to what many think, need not be fully in cash. All it matters is for its monetary value to be easily accessed on demand. It is not uncommon however for a War Chest to be entirely in cash. What this means is that cash sitting in the bank savings account is earning a petty interest, waiting for “the day to be deployed”.
Remember, a War Chest just has to be easily accessed on demand. However, this does not mean that your money should stop working for you. A consideration is to invest in short-term liquid investments or liquid cash equivalents such as Fixed Deposits (FDs – 1 to 36 months), Singapore Savings Bonds (SSB – 1 to 10 years), Treasury Bills (T-Bills – 6 months, 12 months). It is also advisable to portion the War Chest into a few rather than lump sum, such that you need only liquidate the required amount when the need for it arises.
It is not a matter of how big your War Chest, but how efficient do you deploy your War Chest.
How well do you manage your War Chest?