Cash is the most familiar of asset classes. Money can be seen and touched, unlike shares and bonds which are more intangible. Yet, what is the role of cash in financial planning?
What are its strengths and limitations? Our Carlisle financial planners offer some insights below, helping you deploy cash effectively in 2025 even amidst rising UK living costs.
Defining cash
The meaning of “cash” may seem obvious, but it has changed significantly in recent years – especially with new technologies which are making British society increasingly paperless.
In 2011, 55% of UK payments were made in cash. By 2032, this is expected to fall to 7%. Indeed, the Bank of England (BoE) is now even talking of a “digital pound”, which could link to the government’s National Payments Vision – i.e. a huge ecosystem for online payments.
Cash, in short, is changing. As such, it is important to define the key characteristics that set it apart from other financial concepts, like shares or bonds. These include being:
- A store of value.
- A means of deferred payment.
- A unit of measurement.
- A medium of exchange.
The strengths of cash
Few assets are as liquid, secure, and flexible as cash. The first (“liquidity”) refers to how fast an asset can be converted into cash without losing value. Shares, bonds and property can take time to sell and may experience price volatility. Cash, however, is immediately available.
This makes cash ideal for an emergency fund. If you suddenly face an expense like a broken boiler or medical emergency, a savings or money market account is your lifeline. Our Carlisle financial planners usually suggest building 3-6 months’ worth of living costs in an emergency fund (e.g. an easy-access account).
A cash reserve can also let you take advantage of financial opportunities. Perhaps a property suddenly arrives on the market for a very low asking price. Or, maybe a business owner exits and retires, giving you a chance to buy their shares.
Cash is integral to the UK economy, so the government has implemented measures to instill confidence in taxpayers that their savings are safe. A case in point is the Financial Services Compensation Scheme (FSCS), which guarantees up to £85,000 per person per authorised firm (e.g. a bank).
Drawbacks
Cash is not without its issues, however. In particular, it is susceptible to value erosion due to inflation (the overall rise in the price level for goods and services).
Suppose your cash savings account gives you 1% interest per year. In that time, inflation rises by 3%. Although your bank statement will show an increase in your balance by the year-end, the money has lost 2% in real value (i.e. spending power).
For this reason, cash is widely considered a poor asset class for building long-term wealth. Other assets – e.g. equities, bonds and property – offer higher potential for return on investment (ROI). In short, keeping too much cash can incur an opportunity cost.
Another case in point is the “dry powder fallacy”. Some investors believe they can boost their investment returns by holding a lot of cash (dry powder) in reserve – only investing it when the market drops (to ride it back up again afterwards). However, this strategy is very difficult to implement consistently. Rather, evidence suggests that a better approach is simply to invest the cash gradually and consistently – e.g. every month (“pound-cost averaging”).
Integrating cash into a financial plan
The role of cash looks different for everyone, depending on their unique financial goals, needs, risk tolerance and situation. However, some general principles apply in most cases.
Firstly, our Carlisle financial planners tend to guide clients towards using cash for short-term financial goals, such as putting a deposit down for a first mortgage in the next 3-5 years.
This is because other assets (e.g. shares) are more price-volatile. For instance, if a market crash occurs, there may not be time for the investments to recover. Cash, by contrast, is stable and can provide far more predictability.
As mentioned, cash is useful for an emergency fund (3-6 months’ worth of living costs), as this helps avoid turning to credit if a large expense comes your way.
Cash can be useful for tax planning. In 2024-25, the Personal Savings Allowance (PSA) lets a basic rate taxpayer earn up to £1,000 from interest every year without paying tax on the interest. By contrast, dividends and capital gains are subject to separate taxes and allowances.
Cash is generally a safe and stable asset, but it should be balanced with other investments to optimise financial growth. A well-diversified financial plan includes a mix of cash, stocks, bonds, and other assets to achieve both security and long-term growth.
We hope this content gave you more clarity. To discuss your own financial plan, please get in touch to arrange a free, no-commitment consultation with an adviser here in Cumbria.