How much cash should you hold? In 2022, this has become a pressing question with inflation running high (eroding the value of savings), rising job insecurity (due to fears of recession) and rising interest rates. A general guideline is to hold 3-6 months’ worth of living costs to help cover your needs in an emergency. However, is it wise to save more than this? When should you start turning to other assets instead? Our Carlisle financial planners at Vesta Wealth offer some insights in this guide below.
Why should I hold cash?
Cash has two main advantages as an asset class. Firstly, the value of £1 does not fluctuate with the stock market. Apart from inflation and currency exchanges, you can be fairly certain of what it will be worth in the near future. Secondly, cash has high “liquidity” – meaning you can access and spend it quickly if needed (assuming it is in an easy-access account).
Holding a decent sum of cash is wise because it helps you avoid turning to debt when sudden, costly life events catch you by surprise. In 2021, for instance, 40% of people in one survey said they had a “surprise cost” between £501-£1,000 such as a property repair. About 10% reported total costs exceeding £3,000 for the year.
A strong cash reserve also opens up options. If you decide you want private treatment for a minor ailment, for instance, then using cash might be cheaper than paying the excess and premiums on a PMI policy (private medical insurance).
Reasons not to hold too much cash
Many people assume that their cash savings grow slowly in value each year. After all, your bank sends a statement showing how much interest you have earned. However, inflation works in the background against savings. As the cost of living rises, the “buying power” of your money falls. If a £1 item rises by 10% inflation over a 12-month period, then you will need £1.10 to buy it 12 months later. If your savings account only offers a 1% interest rate, moreover, then your savings will not keep up with inflation.
Over time, the value of cash tends to fall in real terms. This is especially true in 2022, with inflation riding at a 40-year high of 9.1% and easy-access regular savings accounts offering just 1.56%. Investments, however, can outperform cash holdings over the long term – also helping to protect the overall value of your wealth during higher periods of inflation.
To put this into sharper focus, imagine you put £10,000 into a savings account in 2010 (assuming, for simplicity, a 0% interest rate). According to the Bank of England’s (BoE) calculator, inflation averaged 2.7% per year between 2010-2020. Broadly, therefore, goods and services costing £10,000 in 2010 would have cost £13,112.60 in 2020. This means that you would have “lost” £3,112.60 in real terms. However, had the £10,000 been put into an investment portfolio averaging over 2% per year, then you would have beaten inflation and made a real return.
Where to place cash within a wider portfolio
Cash is just one asset class out of many others that may feature in your portfolio including fixed-income securities (bonds), equities (stocks & shares), property and commodities. The balance you should hold between them varies according to your financial goals, circumstances, risk tolerance and investment “horizon” (i.e. the length of time until you need the money).
Suppose you are looking to place a deposit on a house within the next 5 years. Here, it may be best to concentrate on building savings within a fixed-rate account after using up your Lifetime ISA allowance. In this scenario, you do not have a lot of time for investments to recover their value if a stock market crash occurs between now and your property purchase date. However, if you are prepared to take on more risk, you might want to apportion some of your house deposit contributions into equities – to try and benefit from the higher growth potential.
If you have recently come across a large lump sum – e.g. from a business sale or inheritance windfall – then you may suddenly find that cash comprises an overly-large portion of your overall portfolio. In cases like this, it can help to seek financial advice to make sure you allocate it in the wisest, most tax-efficient manner. After all, if you invest it all at once into equities, what happens if the stock market then crashes? Here, one option could be to “drip-feed” (pound-cost average) the cash into an investment portfolio over time.
Another idea is to pay down costly debts with a high interest rate. Credit cards, for instance, typically charge between 8.9%-23% APR, which is far higher than interest rates from regular savings accounts – as well as the returns from many investments!
Summary
Ultimately the right amount of cash for most people to hold will be that general guideline of 3-6 months’ worth of living costs. This emergency fund should be enough to cover any unforeseen problems such as your boiler breaking down.
If you have a short-term investment objective, such as a house purchase, then holding more can be sensible. However, holding too much cash means the value of your assets will likely be eroded by inflation. If you are unlikely to access or need that money in the near term then the investment may provide the opportunity for inflation-beating growth.
Invitation
If you are unsure of the right amount of cash you should hold, or would like to discuss your financial plan and retirement strategy, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.
Reach us via:
t: 01228 210 137
e: [email protected]
This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.