Is cash really king?

Is cash really king?

8th October 2021, 11:21 am

It’s always good to have some liquid funds available to provide flexibility, but with interest rates at an all-time low and the rate of inflation hovering around 2% – is surplus cash best saved in the bank? Financial Adviser Becky Sugden looks at the options available and how returns can differ.

Saving and investing are not mutually exclusive concepts, they are strategies that should be employed simultaneously to meet different needs and address different types of risks.

The initial impact of measures introduced to address the spread of COVID-19 illustrate the need to hold cash to cover emergencies. Having cash set aside can provide households and/or businesses with security and the ability to cope with unexpected costs or periods of financial pressure.

However, people commonly hold too much cash in the bank. Inflation (or price rises) erodes the ‘real’ value of money on deposit in the long term, at a rate higher than interest received. The rate of inflation, measured monthly by the Consumer Price Index (CPI), was 1.2% above target at 3.2% in August 2021.Temporary global supply chain issues are affecting prices, but the inflation rate is expected to normalise overtime once global supply constraints have eased.

However there are also several economic factors that have significantly changed over the last 18 months which might impact prices further.

Government and central bank policy across the developed world have acted to support economies during the COVID-19 pandemic and the strategies employed have been inflationary.

In March 2020 the Bank of England reduced interest rates to 0.1% and their quantitative easing programme (QE) almost doubled, they now own £895bn bonds. This was necessary to help keep the rate of borrowing low which has helped to support increases in government spending and initiatives such as the furlough scheme. These strategies were historically large and employed across many countries, which now have large debt piles. This may mean that inflation remains higher for longer.

This affects people in two ways, annual expenditure is likely to increase, and the real value of their savings fall. For example, if you earn 0.5% interest on your deposits and the annual rate of inflation is 3.2% then your effective return is -2.7% per annum. If this position remains unchanged in the longer term you will become significantly poorer over time.

Therefore, it is important to consider investing money you do not need in the short term. When you invest you hold assets that may grow ahead of the rate of inflation. The MSCI World Index is a broad global equity index that measures large and mid-cap equity performance across all 23 developed market countries. The returns over a 10-year period have been 287.67% whilst prices (inflation) measured by CPI are 19.5% higher.

With interest rates at rock bottom some might ask why you wouldn’t invest everything you have. An investment portfolio might protect you from inflation, but it does not grow on a linear basis. Your portfolio will move up and down in the short term. In February 2020 share prices fell significantly due to concerns about the economic impact of COVID-19. If you had an insufficient emergency fund and had to sell investments as a result, you would have been at risk of losing money unnecessarily or (at best) taking gains at a less attractive exit point.

In summary having cash protects you from investment volatility in the short term and having investments protects you from inflationary risks in the long term. You should balance your savings and investment strategies accordingly.

Personal circumstances differ and not all of this information is applicable to every client and/or their business, this information is general in nature and should not be relied upon without seeking specific professional financial advice.

Articles should not be relied upon in their entirety and shall not be deemed to be, or constitute, advice. Although endeavours have been made to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of any articles. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts. Levels and bases of, and reliefs from, taxation are subject to change and their value depends on the individual circumstances of the investor. The value of your investments can go down as well as up and you may get back less than you invested. Past performance is not a reliable indicator of future results.

Pareto Financial Planning Ltd is authorised and regulated by the Financial Conduct Authority.

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