Are You Holding Too Much Cash?
Cash has an important role in almost every financial plan. It provides security, flexibility and peace of mind – particularly in retirement.
But it is also possible to hold too much.
After several years of relatively attractive savings rates, keeping money in the bank can feel reassuring. There is no investment market volatility to worry about, the value on your statement doesn’t fluctuate and your money is readily accessible.
However, cash isn’t completely without risk.
The hidden risk of inflation
The biggest long-term risk to cash is inflation.
If the interest you receive does not keep pace with rising prices – particularly after allowing for any tax – the real spending power of your money gradually falls.
For example, with inflation averaging 3% a year, something costing £10,000 today would cost approximately £13,400 in ten years.
So while £100,000 sitting in a bank account may still say £100,000 on the statement, what really matters is what that money will buy in the future.
How much cash should you keep?
There isn’t one answer that is right for everyone.
We generally think about cash in terms of what the money is actually for.
It makes sense to retain readily available cash for emergencies and unexpected expenditure. You may also want to hold money for known spending over the next few years – perhaps a new car, holidays, home improvements or helping children or grandchildren.
For clients taking an income from investments in retirement, having an appropriate cash reserve can also provide valuable flexibility during periods when investment markets are weaker.
The question becomes more important when substantial amounts of cash are being held without any particular purpose and are unlikely to be needed for many years.
Cash or investments?
Money that you are likely to need in the short term generally shouldn’t be exposed to unnecessary investment risk.
For money with a longer timeframe, however, accepting some investment risk may provide greater potential to maintain or increase its purchasing power.
That doesn’t mean moving everything from cash into investments. A good financial plan normally involves a combination of cash and investments, with each doing a different job.
The appropriate balance will depend on your circumstances, income requirements, attitude to investment risk and future plans.
Don’t forget tax
Interest on savings can also create an unexpected tax liability.
Depending on your tax position and the amount of interest you receive, some of your savings interest may be taxable. This means it is important to consider the net return after tax, rather than simply the headline interest rate advertised by the bank or building society.
ISAs can therefore remain particularly valuable, as interest and investment returns within an ISA are generally free from UK Income Tax and Capital Gains Tax.
Check where your cash is held
If you hold substantial cash deposits, it is also worth considering the protection available should a bank or building society fail.
The Financial Services Compensation Scheme (FSCS) provides protection for eligible deposits, subject to its prevailing limits and rules. Remember that different banking brands can sometimes operate under the same banking licence, so it is worth checking how your deposits are structured.
Give every pound a purpose
Rather than asking “How much cash should I have?”, a better question may be:
“What is this money going to be used for, and when am I likely to need it?”
Money needed soon may quite reasonably belong in cash. Money that isn’t expected to be needed for ten or twenty years deserves a different conversation.
As part of our regular financial planning reviews, we consider not just your pensions and investments, but also the cash you hold and whether the overall balance remains appropriate for your plans.
Sometimes holding plenty of cash is exactly the right decision. At other times, a large cash balance has simply accumulated over the years without anyone stopping to ask whether it is still the best place for it.
The important thing is that your cash is there for a reason, rather than simply there by default.
If this blog has raised any questions why don't we have a quick chat?
MD & Certified Financial Planner
A brief meeting might be of interest, especially if you’re unsure just how wealth management and financial planning could help you.
It would only require the investment of an hour or so of your time, and the coffee’s not bad either.