Investing is great. You should invest. Don’t sit on cash. Don’t let your handwork be eaten away by inflation. These are great lessons for a bull market.
But when the markets fall, either of two things happen:
You get worried seeing all your wealth reducing in value, and you exit your investments at losses (not good)
You see stock prices like you see a Christmas sale, and jump to buy those stocks that you like at cheaper valuations (good)
But do you have the cash to buy stuff when the markets fall? Here’s how to navigate this.
What is dry powder?
Dry powder is slang for the reserves funds keep aside by individual, companies or funds to cover further obligations, purchase assets or make acquisitions.
Dry powder in the case of individuals refers to the cash that you need to keep aside as liquidity. This money has to usually be easily accessible, have no exit barriers and have no downside risk.
This can be in the form of:
Current or savings accounts in banks
Money market funds
How much liquidity to keep?
Liquidity is required for a variety of purposes, including everyday expenses and emergency funds. How much liquidity you need depends on your socioeconomic condition.
Age: As you age you become more likely to incur surprise expenses like medical emergencies. This requires you to maintain liquid savings in to meet these unexpected demands.
Dependents: The risk of unexpected expenses rises with the number of people being supported by an income stream. If you have spouse, parent or child to financially support your cash savings need to be higher.
Risk Taking Capacity: If you are financially strong, you have a higher capacity of risk taking. Rather than hoarding cash you can earn better returns by investing that money.
Other Investments: All your money is tied up if you invest your savings in real estate, your need for cash savings would be very high. A stock market investor who can liquidate in two days and needs relatively less cash.
Monthly Income to Expenditure: If your monthly income isn't much greater than your expenditure you are very susceptible to working capital problems. You need to hold more cash incase of emergencies or delay in income.
One point usually ignored by individuals and advisors is ‘market conditions’.
Dry powder during market conditions
There are two market conditions that you need to adjust your liquidity situation to:
Upwards - When the general trend is bullish, and you are making money on anything you touch, you need to be invested fully, or at least to as much as you can. During this time, having too much liquidity leads to ‘cash drag’. It simply means you will be missing out on some valuable returns.
Downwards - When the markets are in a state of angst and worry, with several major downfalls that appear spooky, you should be ready to deploy more capital, and buy the things you want. Sitting on excess cash at this time is okay, as you patiently get better entry points, over a period of time, average your cost out, and get more profits when the markets rise. Buy low, sell high. Remember.
This is a time to deploy money
Current market conditions have been offering several buying opportunities. But if you’re invested to the brim, you’re probably losing sleep over how much money you’re losing.
It is a good time to have some liquidity, to be deployed into the markets when they fall. Take the last 2 weeks for example, the markets have fallen by 8%. A lot of stocks have fallen by more than 30%, and many of these are good companies, that you could add to your portfolios. It is a good time to have the money to buy these stocks at a lower price.
So either utilise some of your excess cash, or save up on your next salary to buy some of these stocks at a discount!