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This Warren Buffett money tip could help you to beat the FTSE 100

Peter Stephens
close-up photo of investor Warren Buffett

While the FTSE 100 may have recorded annualised total returns of around 9% since its inception in 1984, outperforming the market could improve your financial outlook.

For example, Warren Buffett has consistently beaten the S&P 500 during his career. This has enabled him to become one of the wealthiest people in the world.

As such, following his advice could help you to outperform the stock market. One area where Buffett’s views could be beneficial in this regard is his view on cash, and how it can provide you with the means to capitalise on the cyclicality of the FTSE 100.

Buffett’s cash pile

Although Warren Buffett invests the majority of his wealth in the stock market, he also has a large amount of cash at all times. In fact, he has always maintained a large cash surplus to provide peace of mind, and also to benefit from the buying opportunities that are presented whenever the stock market experiences a bear market.

This occurs fairly regularly, with the most recent one being the global financial crisis. In that period, Buffett was in a very different position to most investors. Certainly, many of his holdings had fallen in value as the prospects for the world economy appeared to be relatively uncertain. But, unlike many of his peers, he had significant amounts of cash that could be deployed in companies that were trading on low valuations.

This approach meant that he was able to capitalise on the cyclicality of the stock market. Its bear markets have always been followed by recovery and bull runs, which has led to the ‘Sage of Omaha’ becoming fabulously wealthy.

Building your cash pile

The challenge with holding cash at the present time is that it offers a return that is below inflation. In other words, it is losing its value in real terms while investors wait for a market crash to buy undervalued shares.

However, since the world economy faces a number of major risks at the present time, a difficult macroeconomic period may not be a major surprise and means compromising by holding some cash may be worthwhile in the end. Having some cash available through which to benefit from lower valuations that may occur over the medium term may make it possible to improve your long-term returns.

One way to build up cash if you are fully invested is to sell some shares. However, another strategy could be to hold your dividends as cash. This would avoid commission costs, and could allow you to gradually build a cash pile that can be deployed when the next major global recession and bear market strikes.

As history shows, no bull market has lasted forever. Therefore, planning for the next one, and how you will react to it, could help you to outperform the FTSE 100 in the long run. It may even boost your wealth in the coming years.

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Peter Stephens has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Motley Fool UK 2019