Should you rely on cash? The case for investing
This content is for information purposes only and should not be taken as financial advice. Every effort has been made to ensure the information is correct and up-to-date at the time of writing. For personalised and regulated advice regarding your situation, please consult an independent financial adviser here at Castlegate in Grantham, Lincolnshire or other local offices.
Many people view cash as a “safe” place to put their money. Compared to investing, cash savings appear more stable and secure. However, cash is not risk-free and can incur opportunity costs, which may not be immediately apparent. Here, investing can help.
Below, our Grantham financial planners explain how cash can help individuals achieve certain financial goals, where its limitations lie and how investing can address many of its shortcomings.
We hope these insights inspire you, and we invite you to get in touch with any questions, or to arrange a no-obligation financial consultation at our expense:
01476 855 585
info@casfin.co.uk
The role of cash in a financial plan
Cash is the most familiar asset type for the vast majority of people. We use it for daily spending and store it away in regular savings. Indeed, the British pound (GBP) fulfils four critical criteria as our national currency:
- It acts as a measure of value
- It can store value
- It provides a means of deferred payment
- It acts as a medium of exchange
As such, cash naturally lends itself to budgeting (managing regular income and expenses). Its second function—a store of value—also makes it useful for a “rainy day fund”, e.g., holding 3-6 months’ worth of living costs to cover sudden, large emergency costs.
However, cash begins to deteriorate as a viable option when individuals consider how to build long-term wealth. This is due to two main factors: inflation and opportunity cost.
The shortfalls of cash
Cash may seem to be a reliable store of value. For instance, the savings in our bank accounts do not “swing” frequently as share prices do on the stock market. Yet, in the background, inflation often erodes the value of cash savings over time.
For example, over the last decade, the average instant access savings rate in the UK was 2.77% as of April 2024. However, between late 2021 and early 2024, the inflation rate has greatly surpassed this. In October 2022, it reached a 41-year high of 11.1%.
Taking these two figures together, cash savings typically lost value—in real terms—over this period. While someone’s bank statement might have shown their cash savings growing by 2.77% due to interest, they could have lost 8.33% in real spending power at an 11.1% inflation rate.
This helps explain why focusing a portfolio on cash is usually unwise when building long-term wealth. If savings cannot match or exceed the rising living costs, they lose their spending power in real terms.
Moreover, the issue of opportunity cost is also important. In other words, could an individual have attained a better rate of return by investing (e.g. in equities) rather than by putting their money into cash savings?
The S&P 500 (the leading stock market index in the US) is a good case in point. Over the ten years before September 2023, its average return stood at 12.39% – nearly 10% higher than the average instant access savings rate in the UK over a similar period.
Whilst we cannot rely on past performance to predict future results, this example helps to highlight the potential of other assets as long-term investments, compared to cash.
Where does cash “sit” in a financial plan?
Cash has an important role to play in most individuals’ financial plans. The issue many face, however, is over-reliance on cash. A more effective approach is to prioritise different asset types depending on a range of factors. These include:
- Your time horizon (when you will need the money).
- Your attitude to risk and volatility
- Your unique financial situation – e.g. your “asset base.”
- Your specific goals as a saver/investor
Cash is important due to these factors (amongst others). For instance, suppose an individual recently lost their job and has depleted their emergency fund. This person will likely benefit from focusing on rebuilding 3-6 months’ worth of easy-access savings in the short term. If she faces another financial “setback (e.g. a major home repair), she will have savings to draw upon rather than facing the temptation to turn to credit.
Another person might have a strong “safety net” for their finances. However, their pension is not on track to achieve a comfortable retirement fund in 20-30 years’ time. Fortunately, this individual still has time to build up a healthy “pot” over their career—e.g., by making regular contributions to their available schemes.
In this case, cash will be less viable for building long-term wealth. Inflation will erode much of its value over the decades, with interest unlikely to keep up with the rising cost of living. Rather, asset classes such as equities and fixed-income investments (e.g. bonds) will be more viable options to consider.
Here, the investor will need to carefully consider their time horizon, risk/volatility profile, goals and diversification strategy to choose an appropriate asset “mix”. A financial adviser can be helpful during this process, guiding the individual through the complex considerations and “macro landscape” which bear upon decision-making.
Invitation
If you are interested in discussing your own financial plan or investment strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense:
01476 855 585
info@casfin.co.uk
