What’s the role of cash in financial planning?
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, Lincoln or other local offices.
Even in today’s increasingly “cashless society”, cash – pound sterling – is still the dominant form of currency and financial jargon we deal with on a regular basis. We use it to pay for essentials and luxury items, commit it to savings accounts and are paid by employers in this form too. Yet how, exactly, does cash play a role across your whole financial plan – particularly when it comes to your investments? After all, cash is just one asset class amongst many other possibilities for populating your portfolio.
In this article, our financial planning team at Castlegate examines the role of cash within a wider financial plan and investment portfolio. We hope you find value in this content. If you would like to discuss any of these matters or discuss your own financial plan with us please get in touch to arrange a no-obligation financial consultation, at our expense:
01476 855 585
info@casfin.co.uk
Cash as a value measure
How do you know how much your house is worth? What about your equity portfolio, the antique art collection in your home or the business you own? Since it is so widely used and understood by most people in society, “cash” is often used to refer to an asset’s value if it can be converted into cash. If your equity portfolio could be sold right now to other investors and you get £10,000 for all of it, then this represents its cash value. The challenge, of course, is that cash changes in value due to inflation (the rising cost of living). £1 may buy you X amount of goods in 2021 but will likely buy only a fraction in 10 years’ time. Another challenge is that not all assets can be sold quickly for cash. Property is a classic example. It can take months to sell a house, in which time its value may diminish and various other costs (e.g. solicitors’ fees) eat into the proceeds that you finally get when the transaction is complete.
Cash as liquidity
One of the biggest advantages of cash is that it can usually be accessed quickly and put to use. Many assets – again, property is a good example – are highly illiquid as they are often difficult to sell quickly to obtain cash to spend where you need to (e.g. in an emergency). Cash itself, on the other hand, can be attained in minutes from a nearby ATM or transferred quickly from an online bank account. The main exception to this is when you have chosen to tie up your cash in a particular investment “wrapper” – such as a 2-year fixed-rate ISA.
The liquidity of cash makes it a useful asset class for financial protection, particularly for a “rainy day fund” where you keep 3-6 months’ worth of living costs at hand should you need to support yourself in the event of job loss. From another perspective, cash is also highly liquid for positive reasons; it can be quickly “spent” to buy other assets such as equities and bonds. It opens up investment options for you later if you are not sure where to invest right now.
Cash as an investment hedge
Various investments have different strengths and weaknesses. Equities, for instance, are often highly volatile; the stock price of a company will fluctuate each day, sometimes wildly and almost always unpredictably. Yet the advantage of equities is that, over the long term, they can produce higher returns compared to other assets (e.g. fixed-income). This is where cash can be useful as an investment “hedge”. This means using assets which are not volatile – such as cash – to offset the risk of adverse price movements in other assets.
For instance, suppose you have a portfolio comprising 50% cash and 50% equities. The latter drops in value by 20% following a stock market crash (like the one in March 2020, following the first COVID-19 lockdown measures in many developed countries). Whilst your equity portfolio may decline in the short term to follow this, the value of your cash will not be affected by stock market movements – providing some protection to the overall value of your portfolio. However, this advantage of cash does need to be offset against its “opportunity cost”.
Here, we mean that cash typically offers investors very low rates of return compared to other assets. By holding too large an amount of cash in relation to these investments, therefore, an investor may be missing out on the returns that he/she could otherwise be generating. It can help immensely to talk to a professional financial adviser to ensure you are striking a healthy balance. After all, you do not want too little cash so that you are forced to turn to credit in a financial emergency, but not too much so you are stifling your portfolio’s potential growth.
Conclusion & invitation
If you are interested in discussing your own financial plan or protection strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense:
01476 855 585
info@casfin.co.uk
