Let’s be fair, Cash is not the most exciting asset class in the world, returns are historically low, inflation and in some case product charges eat away at the return and you are at the mercy of those pesky banks to tell you when rates change.
So, given all this why would anyone invest in Cash?
Well, there are a number of perfectly sound reasons why someone may consider investing in this most unexciting of asset classes, a few off the top of my head:
- To match a very low attitude to risk where the capital fluctuations of other asset classes such as bonds and equities cannot be tolerated
- As a short term place to hold money until re entering a market
- To prevent capital fluctuations before the money is needed for a specific purpose, for example in the years leading up to retirement and an Annuity purchase
What do Cash investors want?
In our experience Cash investors are looking for two things:
- Low volatility
- A return above inflation so that the buying power of their money is maintained
If I choose to invest in Cash what are the risks?
Whilst you don’t have to worry about fluctuations in the value of your capital, Cash does bring with it a number of other risks:
- Inflation, more of which below
- Opportunity risk, whilst you are sat in Cash another asset class could be rising significantly, this demonstrates a wider problem with people trying to ‘time the market’
- Institutional risk, although this can be managed by ensuring you have less with each bank or building society than the FSCS (Financial Services Compensation Scheme) limits
The most serious of these risks is arguably inflation.
So, why is inflation such a risk?
Let’s start by putting the problem into context and cast our minds back five years to 2007. The Consumer Prices Index (CPI) stood at 2.1% with Bank Base Rate at 5.75% and fixed rates available for savers in the 6 – 7% range.
Coming right up to date, in October of this year CPI was 3.2% with Bank Base Rate at 0.5%. The relationship between CPI and Bank Base Rate has inversed, with the situation being even worse if you are looking at RPI or indeed a member of the older generations who suffer a higher level of inflation.
Getting a return to beat inflation is possibly harder now than it has ever been, and remember, once you have used your tax free ISA allowances it is the net, after tax return, which needs to be above inflation if the buying power of your money is to be maintained.
The following table illustrates the problem:
|Gross rate needed to beat CPI||Length of fixed rate needed to provide gross rate|
|Cash ISA||3.20%||2 years|
|20% tax payer||4.00%||3 years|
|40% tax payer||5.34%||No accounts available|
|50% tax payer||6.40%||No accounts available|
Source: Investment Sense Best Buy Tables
But isn’t the current bout of inflation only a blip?
As 2010 has worn on this view has become less prevalent and with the VAT rise just around the corner it appears that inflation at these levels, and possibly even higher is here to stay, don’t just take my word for it:
“CPI inflation is expected to remain above target, and at a somewhat higher level than expected three months ago, for a period of a year or so” Mervyn King, Governor Bank of England
Furthermore it seems the prospect of any short term rise in interest rates are slim, so it’s down to you to do the best you can with your Cash.
“I want to invest in Cash, what should I do?”
Well, the first thing to do it get the tax wrapper right, if you can reduce the tax paid, you effectively increase the rate you get.
Choosing the tax wrapper
Firstly make sure you utilise your Cash ISA allowances, £5,100 for each person in the current tax year. Yes, we all know banks and building societies generally pay a lower rate of interest on Cash ISAs than they do on other similar accounts but a Cash ISA is still generally worthwhile for the vast majority of people.
Next, if you are married or a couple make sure that your Cash is held in the name of the lowest taxpayer and if one of you is not a tax payer make sure that an R85 form is completed to ensure interest is paid gross
Consider tax free products as well, unfortunately National Savings & Investments withdrew their Index Linked bonds earlier in the year, but if they ever return savers are likely, depending on the terms, to dive into these with enthusiasm.
Once you have sorted the tax, you will then need to shop about, looking for the best rate of return you can get for the type of account which suits you.
In the current climate a taxpayer will need to tie up money for at least two years to beat inflation, but beware of tying money up for too long and being left with an uncompetitive account in years to come if rates rise.
Cash held in a self invested pension
For various reasons self invested pensions (SIPPs and SSASs) are often invested in Cash. In addition to getting a return above inflation there are a couple of other problems unique to pensions:
- The range of deposit accounts which a self invested pension can open is small and information about the best rates is not easy to find. This is why we put together a best buy table for deposit accounts which can be held in a self invested pension, this table can be found by clicking here
- Not every SIPP or SSAS will allow access to every deposit account, some are restricted to just one, generally unattractive account, whereas others will allow unfettered access to the entire market
There are many good reasons to invest in Cash. It is an often overlooked asset class, but given the unique circumstances we find ourselves in needs close management.
If you are to spend any significant amount of time in Cash then your money will have to work hard for you to beat inflation. Start by doing everything you can to reduce tax and then think about how long you are prepared to tie up your money for, then review on a regular basis to make sure your money is working as hard for you as possible.
We are here to help you manage your cash more effectively, call us on 0115 933 8433 or 0845 074 7778 and ask to speak with one of our highly qualified and knowledgeable advisers or why not use our free Cash Management Service, click here for more details.