Would it be easier to just hold our money in cash?
As part of this series, we’ve slowly been working our way through the different parts of an investment portfolio, from those historically ‘more risky’ to those ‘less risky’.
This week, we’re looking at what is widely regarded as the safest way of holding money: cash. That is, not putting it into any sort of investment vehicle (like equities or property) and just keeping it in a bank account or cash Individual Savings Account (ISA).
Hopefully, by the end of this, you will understand why it’s not always the safest option.
An unfair race: cash vs inflation
Inflation is a measure of living costs, and so to stop our hard-earned cash losing its value, we want it to perform better, or at least keep pace with, inflation.
Over the past 30 years, inflation has been (on average) 2.54%, reaching a high of 8.5% in 1991. Inflation is part of a healthy economy and the Government target is 2% per year.
This means that we may want our savings to grow at least, on average, 2.54% a year. Without this, our money is effectively losing it’s purchasing power. Some savings accounts may offer this, but holding money in a bank account would very rarely ever give you this level of return.
A good way to show how inflation affects the future, is to see how the price of 6 eggs has changed over the past 30 years:
That means that in 1989, you would have been able to get yourself 6 eggs for 92p. However, in January 2019, the price of 6 eggs has more than doubled and you would need £1.96. So, if you left your money in cash in 1989, your 92p wouldn’t be able to buy exactly the same thing 30 years later.
Advantages of holding money in cash
- It is safe, in terms of not being at risk of going down (although the real value of your cash goes down over time)
- Your money is protected by the Financial Services Compensation Scheme (FSCS) up to £85,000 per institution if the bank or building society goes bust.
- Cash is easily accessible in times of emergency.
Disadvantages of holding money in cash
- The effect of rising inflation and therefore living costs could mean that your money will have less purchasing power in the future.
- You could be missing out on returns which could provide you with more in the future (but also could provide you with less!)
Future of investing in cash
Everyone should hold a bit of cash for emergency funds just in case the worst happens. Also, the level of cash you hold depends on how much risk you NEED to take. For example, if you have ample funds, and no requirements for ever spending them all, it could be a sensible thing to hold it all as cash.
Despite the potentially reducing purchasing power, if you’ve got enough, you’ve taken very little risk. However if you’re looking for your hard earned money to keep pace with or even exceed inflation, there could be better alternatives over the medium to long term.
With investing your capital is at risk at all times and you may get back less than what you put in. The value of your investments can go up as well as down.