Figures from HM Revenue and Customs (HMRC) suggest that some Brits may be holding too much cash in reserve. While it’s a strategy that can seem more secure, it could actually be harming your long-term financial security.
The statistics show the amount of cash people are holding has doubled since the turn of the century:
- In 2001-2005 the figure stood at £363 billion
- By 2014-2016 this had increased to £711 billion
While cash is an important part of your overall financial strategy, holding too much of your wealth in cash could prove risky.
Why cash isn’t always king
You’ve probably heard the phrase ‘cash is king,’ but that’s not always the case. It’s true that cash does offer you more protection. After all, your wealth isn’t exposed to investment market volatility, providing a level of security as a result. Assuming you stay within the limits of the Financial Services Compensation Scheme (FSCS), your money is even protected should your bank or building society fail up to £85,000 per individual per registered institution.
However, there’s one key factor that makes cash less attractive; inflation.
The money sitting in your bank is unlikely to grow at a pace that keeps up with inflation. This has been particularly true since the 2008 financial crisis when interest rates were slashed. Over time, this means the spending power of cash is eroded. A difference between interest and inflation of a few percent a year may seem like little to worry about, but over the long term, it can have a significant impact.
Trevor Greetham, Head of Multi-Asset at Royal London Asset Management, said: “Outside of residential property, cash makes up the largest proportion of estates held by all but the wealthiest households. Cash is the safest asset in the short term, but in the long term, it is one of the riskiest.
“With interest rates set below the level of inflation the purchasing power of cash has fallen markedly in the decade since the financial crisis, even with interest reinvested.”
How much should you hold in cash?
There’s no one-size-fits-all answer to that question, it depends on your individual circumstances and what your plans are.
However, there are some general rules to consider. First, an emergency fund should be held in cash. Generally, it’s recommended that this is between three and six months’ income. Having rainy day savings in a cash account means it’s readily accessible when you need to use it. It’s a fund that provides you with a financial buffer, should you encounter an unexpected bill or your regular income stops.
Beyond this, you should think about the level of money that needs to be accessible to you in the next few years. This will be entirely dependent on your goals. Typically, you should invest with a view of leaving your money in investments for a minimum of five years. This gives you a greater opportunity to ride out potential dips in the market. As a result, the amount of cash you should be holding is directly linked to your wider financial plan.
Isn’t cash better in a volatile investment market?
If you’re holding much of your wealth in cash, it’s easy to think it’s the best option. After all, the value of investments rise and fall all the time. It may be a level of uncertainty you’re uncomfortable with. The last twelve months have seen volatility for investments, influenced by a range of global factors. It’s normal to have some concerns when you’re considering investing in light of this.
However, investing should be undertaken with a long-term view. Historically, investment markets have delivered returns when you look beyond the short term. When you look at how they’ve performed over a ten-year span rather than a year, investments potentially deliver a return that allows you to outpace inflation. With the right investments, you may not only be able to maintain your wealth relative to inflation but increase it.
It’s important to keep in mind that not all investments carry the same level of risk. If you’re cautious about investing and simply want to maintain your wealth, there are investments that carry a lower level of risk. Weighing up your attitude to risk and your personal situation is critical when choosing an investment portfolio that’s right for you.
A well balanced financial strategy should consider the short, medium and long term, blending cash accounts, investments and other vehicles to build a bespoke blueprint that reflects goals.
How does the amount of cash you hold reflect your wider financial plan? If you’d like support in reassessing your financial strategy or would like to start investing, please get in touch. We’re here to help you identify the steps that could match your ambitions.
Please note: The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.