piggy bankI’ve been giving a lot of thought lately about my investing process.  My strategy is to invest in dividend growth stocks and currently I put any money I have available to use right away by making a purchase of stock in one of the companies on my watch list.  The ideas is that I am buying shares as soon as I can allowing me to immediately benefit from any dividends paid by my companies and any dividend growth.  Lately I’ve been contemplating whether it would be a better idea to build up a cash reserve in my stock account so that I can take advantage of any negative market movements that offer up amazing buying points of the companies I would be interested in.  Today I want to take a look at these different processes and why we might consider either method.

Put New Capital to Work Immediately

My current investing process is to put new money to work immediately when I have it.  Usually I will try to accumulate cash until I have about $1,000 and then I decide I am ready to invest.  I try to make minimum purchases of $1,000 to cut down on transaction costs (commissions).  So when I have $1,000 ready to invest I take a look at my stock watch list.  I look at recent price action in the different companies, current dividend yields and P/E ratios compared to the respective companies historical P/E ratios.  At that point I like to pick out 2 or 3 companies that I believe look like good values at the time to do a complete stock analysis on.  Once I’ve done my analysis and think I’ve found a stock either undervalued or fair valued I will make my purchase.

So far this method has worked for me because I feel like I’ve always found a few stocks on my watch list that are currently offered at a good valuation.  I believe that when the time comes that none of the companies I would like to purchase are trading at a good valuation then I will choose not to invest and rather save the cash until I find a company with a more reasonable valuation.  However, since I’ve been dividend growth investing the past couple years I have always felt some companies on my list have been trading at good valuations and I haven’t hesitated to immediately put my money to work by buying some shares.

Build Up a Cash Reserve to Take Advantage of Opportunities

Lately I have been questioning my current process of putting capital to work immediately once it’s available.  I have been considering saving up a reserve cash amount that I can use to take advantage of any great investing opportunities that present themselves.

For example, the short term future of the US stock markets was recently in question due to the Fiscal Cliff being debated in US Congress.  The worry was that if Congress could not come to an agreement to halt across the board tax hikes and spending cuts, the country would plunge into recession and the stock markets would see a large decline.  If the large decline came to fruition, investors with extra cash available would have been able to take advantage buy purchasing some great companies at great discounts.  Unfortunately, I would have been forced to mostly sit on the sidelines and watch as many of the stocks on my list began trading at prices I could only dream of buying them at.  I would have to sit on the sidelines because I don’t have a cash reserve built up to take advantage of this situation.  I probably would have been able to afford about 1 purchase.  I do have an emergency fund that I would have been tempted to tap into, however that is not the type of emergency that I have set that money aside for and my wife would probably have my head if I even thought about it.

So the idea behind this process is that I would slowly begin accumulating a cash reserve in my stock account to be used in times of opportunity.  When we see another recession sometime in the future I would then be able to put that cash to work by purchasing companies at great prices.  I wouldn’t stop investing completely while building up this reserve cash but I would be investing less often because I would be splitting my resources towards the achievement of the two goals of stock investing and cash accumulation.

Conclusion

I really have no idea which method of capital utilization would be better in the long run.  I like purchasing stocks as often as I can.  I’d almost consider it an addiction because I get a rush seeing those shares in my portfolio and seeing those dividends getting paid.  I would probably have a tough time seeing cash available to invest and not investing it.  This is especially true because I am usually finding more companies to buy than cash that I have available.  I feel like I can usually find something at a good valuation to buy.  I know this may not always be the case and when that time comes I will accumulate cash to be used at a later time when stocks are better valued.  The other reason I like to put cash to work immediately rather than later is because I have no idea when the next great stock buying opportunities will present themselves.  I may end up sitting on cash for quite a few years before we have another recession offering great stock prices.  Those could be years worth of dividend income that I would be missing out on.

What do you think?  Do you have cash reserves built up to take advantage of investing opportunities?  Do you prefer to put your capital to use immediately when available?  Please share your thoughts in the comments and your reasoning behind the methods you use!

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17 Responses to Building Cash Reserves for the Perfect Investing Opportunities

  1. Jean-Louis says:

    Thanks for this interesting website and sharing your thoughts! I started investing in growing dividends a few months ago, putting capital to work immediately. I have invested all the money I planned to invest and therefore have to wait a few months to buy my next dividend stock. I now consider your 2nd strategy (cash reserve) as it seems more appropriate to wait for good opportunities, i.e. occasions to buy more shares and increase the dividend you’ll get repeatedly for years. This strategy seems to me in coherence with the long term vision of DGI. What do you finally get by investing your money as soon as you have it available? A few dollars as the quarterly dividend?

    Best,

    Jean-Louis

    • Dan Mac says:

      Thanks for your comments Jean-Louis! I agree you only get a few dollars in quarterly dividend but you also own the shares and get to join in on any appreciation that may happen. What happens if you decide to wait for better opportunities and they never come? How many years will you be willing to sit in cash waiting for the next big recession? I think if I can find companies I want to purchase that are being offered at reasonable valuations, it is best to go ahead and make the purchase. However, if I feel everything I want to own is currently over valued then I will wait and build cash.

    • I invest the money as soon as I receive it. I sometimes even purchase the stocks I chose a few days prior to the cash receipts. The long-term trend in stocks is up. Over the past 200 years, there have been more up months than down months. I think it makes sense to buy stocks as soon as you have the cash, rather than accumulate big amounts of cash that does nothing for you. Of course, I always have at least two dozen dividend stocks to purchase at any moment, which is why I seldom have a material cash position in my brokerage accounts.

      • Dan Mac says:

        Thanks for weighing in Dividend Growth Investor. I agree the long term trend (and we invest for the long term) is always up going back many many years. A good book to read on this is Stocks for the Long Run by Jeremy Seigle. Like you I always have a few stocks trading at prices I’m willing to pay as well. So more often I find the problem not being that I can’t find anything to invest in but that I don’t have enough cash to do the investing. So I usually am forced to pick what I think is the best option to buy when I have the cash available and then am forced to wait until next month when I have new capital ready. I think even now if I had a cash reserve built up I’d have no problem finding multiple companies that I’d be interested in buying.

  2. Jean-Louis says:

    Agree, Dan. Not going to wait years for a big recession. I think there are often opportunities to be found. The question is then how do you know the stock is reasonably or under-valued? I often see the P/E ratio as an indicator of valuation; do you use additional/other indicators?

    Thanks for your help

    Jean-Louis

    • Dan Mac says:

      Jean-Louis, I start out by looking at the P/E ratio. Historically the average P/E ratio for the S&P 500 has been around 14 so I use that as a guide. However different companies have different historical average P/E ratios so I also look at the historical P/E ratios for the companies I am interested in to determine if I think it is selling for a reasonable price currently or not. For example a stock might trade within a P/E range between 16 and 20 over the past 10 years so I might determine that something trading in the lower part of that range might be a good value. I get this info from S&P sheets provided by my online broker but I bet you can find this info out online somewhere. This is only a first step though and once I think I found a company that might be reasonably valued I will do a more in depth analysis. Check out this article for how I go about this. Also this article goes more into detail with how I will value the stock and calculate estimated future returns.

      Another way is to figure out the earnings yield of the company and compare that to the current 30 year US Treasury bond rate. For example I might be interested in a stock that is selling for a price of $20 and has earnings per share of $2. This stock has a P/E of 10 (20/2) and has a earnings yield of 10% (2/20). The current 30 year US treasury bond rate is around 3%. So I would look at it that this company is trading at a pretty good valuation compared to the long term bond rate. It’s also important to look at growth in earnings because growth in earnings is what will drive future capital appreciation and dividend income.

      Hope this helps. Let me know if you have any other questions!

  3. Dan Mac,

    I wrote a lengthy article on this a while back and I came to the conclusion that while it’s usually better to invest as long as you enough capital to make it worthwhile (depending on commission fees) and there is an attractive enough opportunity, it still depends somewhat. I gravitate towards deploying cash as soon as I have it available.

    I think your portfolio size has something to do with this as well. If you have $1 million and you have $10k sitting around it won’t make a big difference to your overall wealth whether you invest it right away or wait a bit. However, if you only have $20k invested and you have $1,500 in fresh capital…it only makes sense to get that money working for you and continue to grow/compound your portfolio.

    Best wishes!

    • Dan Mac says:

      Thanks for the input Dividend Mantra. I agree that portfolio size would have alot to do with it as well. Currently I have a very small portfolio in my opinion so the fresh capital makes a pretty big impact.

      I think the key is to invest when you find good opportunities to invest. If I can’t find anything at a valuation that I am willing to pay then I am better off holding the cash rather than trying to force something. They say even a bad company can be a great investment if you buy it at the right price and a great company can turn out to be a bad investment if you pay too much for it.

  4. When I first started investing in individual stocks I tried to get the capital invested as quickly as possible into stocks that I felt were undervalued from my stock analysis. I still usually get the cash working soon after it hits my account but I’ve been thinking about what I’d do when I can’t find good enough value opportunities. I’m leaning towards building up a cash reserve, but there’s definitely going to be a limit on it. I usually have at least $4k, most of the time more, to invest every month. That would add up quick and in a years time would have $48k sitting around. I think I’d have a limit of around $20k and the rest would either continue being invested by purchasing stocks even if their not at the best valuations or by selling put options to at least get some kind of return on the capital. As my portfolio grows the cash limit would rise as well but there’s no way of knowing when the next big drop in the market is coming so having that cash collecting the very minimal interest that I get in my sweep account tied to my brokerage account would be doing a disservice to my plans of reaching early FI.

    • Dan Mac says:

      JC I agree there would need to be a limit to how much cash you are willing to allow build up without investing it. In that type of situation I don’t know what I’d do. If everything I was interested in buying was majorly overvalued I may look towards keeping some money in bonds or something until the market corrected itself. Possibly some kind of short to medium term bond mutual fund or treasuries fund.

  5. Martin says:

    Dan, recently I went thru the exact thoughts. I saw so many companies out there which were available at great price and I couldn’t buy them, because I didn’t have enough cash on hand. So I made the exact same decision and invest less often and put aside more cash for opportunities. So far it works well for me.

    • Dan Mac says:

      Thanks for your input Martin. I think different strategies can work for different people for sure. I’ve come to the conclusion that when I have cash available, as long as I can find a company I’m willing to buy at current price levels then I will buy it. If I’m unable to find anything that I think is a decent valuation then I will save the cash until better opportunities come along. So far though I’ve always found more opportunities than cash available so I’m at least going to get into one of those opportunities.

      • Martin says:

        Understand, but I keep my range limited based on the portfolio value, so my current value allows me to invest into 4 stocks only (for example), so I either put cash aside or accumulate into the 4 existing stocks if they present an opportunity. If not I stay in cash or trade options. When the portfolio exceeds my value, for example as it happened to me today I can add 2 more stocks into my portfolio and accumulate in now 6 stocks (for example). That helps me not to be overwhelmed by thousands of stocks and opportunities.

        • Dan Mac says:

          I think I understand. If you are limiting yourself to a certain number of companies then I can see how you might not feel they are at a valuation level you want to buy them at. My watch list is around 30 companies that I wouldn’t mind owning so I usually have been able to find something. Are you keeping the number of companies lower for any reason?

  6. [...] Growth Stock Investing considered building up his cash reserve for a perfect investing opportunity.  I tend not to build up too much in reserve; I prefer to have my money working for me as much as [...]

  7. Johnfin3 says:

    I am a converted dividend investor. By that I mean I have been doing it as part of my investing strategy for many years, and now see that I have a chance to go all in, well, as much as I can. With a SD-IRA, both regular and Roth, that makes up 2/3′s of my portfolio, with a 401k at work making up the other 1/3′d. So I have sold all my MFs and taken back responsibility for my investing from my broker. I’ve picked out my planned investments for each of the 2 IRAs, and now I’m waiting for the best time to dive in. In the mean time, I have put in a buy at the lowest 52 Week value for all the stocks I plan to buy, just in case I get lucky. And I will selectively buy in during the next pull back. So far I’ve learned a lot in the last month, and plan to stay tuned.

    • Dan Mac says:

      John, thanks for stopping by! I think you’ll find the dividend growth strategy well suited for your retirement needs. Ideally you’ll be able to save up enough to live off of your annually increasing dividend income during retirement. I think it was a good idea to sell the MF’s and take charge of the investing yourself. Stick to solid blue chip companies with a strong history of increasing both dividends and earnings and you will do just fine over time. Also make sure to diversify so that one bad pick won’t ruin your whole retirement! Good luck!

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