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It is certainly possible to hold too little cash in savings. Yet it can also be possible to hold too much (for reasons explained below). In this article, our team at Cedar House shows how cash can feature prudently within a financial plan – helping to preserve wealth and move you towards your goals. We hope this is helpful to you. If you want to discuss your own financial plan with us, please contact our team for more information or to access personalised financial advice:
020 8366 4400 or enquiries@cedarhfs.co.uk
Why too much cash can be problematic
Cash held in easy-access savings can be very helpful to provide an “emergency fund” or “buffer” in case of hard times. As a general rule, holding 3-6 months’ worth of living costs can help you avoid needing to turn to debt if you suddenly find yourself out of work, for instance, or need to make a costly repair (like a broken boiler). Cash can also be a useful store of wealth for short term financial goals, such as saving towards a mortgage deposit within the next 3-5 years. This is because there is no risk of a sudden market crash eroding the value of your savings. Also, the Financial Services Compensation Scheme (FSCS) protects up to £85,000, per person, in authorised banks (per banking group).
However, cash is generally a poor asset for building long-term wealth. This is because interest rates have been low for some time (despite picking up later in 2022), and inflation is typically higher than these rates. In real terms, therefore, cash savings tend to lose value over time – despite suggestions from your bank statement that you have earned more money from making interest. At the time of writing, for instance, the best easy-access accounts offer 2.75% and the best fixed-rate deals offer 5.05%. Yet UK inflation is currently riding at 10.1%, which means that these accounts could lose savers 7.35% and 5.05%, respectively, in real terms if these rates are maintained. Even during periods of lower inflation (e.g. 2%) the rates offered from cash savings accounts struggle to keep pace, since the Bank of England has historically kept the base rate low during these such periods – leading other banks to also lower their own rates.
What to do with a cash lump sum?
There might be occasions when you find yourself with a large cash lump sum – such as after receiving an inheritance, or following the sale of your business. This can raise difficult questions, as simply storing it in cash for years could result in excessive wealth loss. For instance, if you stored £100,000 in cash on a 5.05% fixed-rate deal, then £5,050 in “real value” would be lost if inflation stood at 10.1% for 12 months. However, simply investing all of your money into shares (all at once) also poses risks. What if the market crashes shortly after you invest the lump sum? Instead, many investors find it more appropriate to pursue a “pound-cost-averaging” approach. This involves “drip-feeding” the money into an investment portfolio over time (e.g. monthly), to try and mitigate the risk of investing everything just before a potential crash.
Cash vs. investing
When investing money, of course, it is important to build a portfolio which reflects your goals, time horizon, risk tolerance and values (e.g. ethical considerations). As such, it can help to talk through your strategy with a financial planner, since the aforementioned will look different from investor to investor. Assets such as shares and bonds can produce returns which beat cash in the long-term, but they also come with distinct risks. UK government bonds (gilts), for instance, recently took a tumble in late September 2022 when the Mini-Budget was released (over fears about how proposed tax cuts would be funded). It is important that you understand the risks of different investments and that you are comfortable with them before building a portfolio.
A financial planner can help you ascertain, first of all, how much of your wealth can be wisely apportioned to cash and how much is better suited to other asset classes. If you have goals such as helping a child save toward university, for example, then this portfolio might involve building up more cash (if he/she starts soon) compared to a portfolio dedicated to accumulating wealth for retirement in, say, 20 or 30 years time. The latter may be able to take on more risk with the investments, since there is plenty of time for the portfolio to recover in the event of a market crash and surpass its previous value. As the years pass, your asset allocation will also likely change as different investments perform differently. Here, a financial planner can help you with “re-balancing” your portfolio appropriately to ensure that your investments continue to reflect your goals, strategy and risk profile.
Conclusion
Interested in discussing your financial plan with an experienced financial adviser? Get in touch today to discuss your financial plan with a member of our team here at Cedar House via a free, no-commitment consultation:
020 8366 4400 or enquiries@cedarhfs.co.uk