Beware the silent cash killer – protect yourself in four easy steps
Your cash savings are diligently accumulated and stored. But how hard are they working for you? Holding onto too much cash is sometimes described as ‘reckless caution’. In other words, playing over-safe with savings can be seriously dangerous for your financial well being.
Is holding onto cash really reckless? The facts suggest Yes. If cash, say, earns 1% a year and UK inflation is higher than 1% – it leapt to 1.8% in January 2020, up from 1.3% a month before – then your savings are losing value daily.
If this sounds like your own situation there’s a number of easy steps to take that will help put your money to work. Let’s get started.
1 – A problem shared
First, you’re not alone. ‘Reckless caution’ affects a lot of us. Back at the start of 2019 Edinburgh-based financial services company Aegon commissioned research on reckless caution.
The Scottish firm found that 40% of all people questioned avoided investment risk and were in danger of ‘reckless caution’. So this predicament affects huge swathes of Britons. As a nation, we tend to squirrel away far more in cash compared to other assets than is healthy.
Yet most of us instinctively know, more or less, the right step to take when straightforward and sensible solutions are presented.
2019 was a strong year for stocks with the MSCI World Index, which tracks developed world shares, leaping more than 23%. The US S&P 500 Index, representing America’s biggest 500 public companies, soared 28% with some pretty big blue-chip performances from well-known names.
For example, Apple shares surged more than 80%. These performance figures beat cash ISA or Post Office rate hands down. Yes, almost all stock markets have tumbled (March 2020) due to the on-going coronavirus anxiety. But this underlines the importance of taking the long view, as well as the possibility of taking advantage of market falls to ‘top up’ at lower prices.
Owning shares in a globally diversified tracker fund, for example, also provides you with a measure of diversification and therefore protection. Not all markets respond to the same crisis in the same way.
2 – Manage the opportunity with a low-risk approach
Investment professionals talk about ‘risk’ all the time. Which is understandable. Buying and selling shares always carries an element of risk. But many financial professionals argue that, in the right circumstances, it’s reasonable to swap ‘risk’ for ‘opportunity’.
Twist around the reasons for not doing so. If cash daily loses value against the cost of milk, washing machine detergent and holidays, why do we sit on our hands?
While it’s sensible to be cautious about investing in the stock market, risk – or opportunity – can be managed by drip-feeding cash in monthly.
Which means you absorb the ups and downs of share prices over time. This lowers risk levels. It also gives you the chance to benefit from longer-term market gains.
Inflation versus cash
“When you measure against inflation,” says AdviceBridge’s James Hoare, “cash has been a disaster over the last decade”. Hoare suggests looking at the effects of real interest rates. That is, the savings rate we can reasonably expect to receive after the cost of inflation is stripped out. “The money in your pocket is eroded because inflation has been higher than savings rates,” he adds. Since 2009 “your money in real terms has been -2.1%”. That’s crushing for your ‘real’ buying power – a double-whammy of low interest rates and inflation. Don’t forget – if you’re putting cash in an ISA you’re paying a fee on top – property funds may rely on having a large cash exposure also
3 – Fix your opportunity comfort zone
Of course, there are variable levels of risk (or opportunity). Almost all investment products from reputable companies offer a spread of options.
For many, a low-cost diversified portfolio including equities, bonds and cash is ideal. It’s up to you to decide what grade strength – how biased it might be to stocks or low-risk government bonds – it is.
How much cash should I really hold?
- The sensible rule-of-thumb is to hold at least several months’ worth of salary or income to manage life’s contingencies – job loss, family illness, etc. “Any more than six months’ worth of cash borders on reckless caution,” advises Hoare
- We all have our own rate of inflation. Inflation is highly personalised (not a very well-known thing). If you are older you tend to spend more on services rather than ‘stuff’ – like a new iPhone (thanks to globalisation largely)
- But buying health or medical care or holidays is often expensive. That’s because inflation rates are higher for such services
- Therefore…older people are more vulnerable to inflation than younger people
4 – Stick to the medium and long-term picture
Getting comfortable with your risk-opportunity level is the next step. This might mean choosing a fund with several diversified assets – shares, bonds and cash. Most evidence demonstrates that shares out-perform building society and bank savings accounts in the long-term.
It also may mean an approach that includes a number of different investment styles. This means when one fund or asset class is out of favour, another fund moves into the ascendant.
As the old saying goes, it’s less about ‘timing the market’ and more about ‘time in the market’. Trying to time the point at which you invest your cash invariably leads to missing the boat as you hold off waiting for a downturn or you are caught out by market rally.
In other words, cash is not King.
But as always, responsible advice comes with the standard disclaimer: the value of shares go up and down and you may get back less than you invested.
- Most simple stock market tracker funds are an excellent way to build a stock market foundation
- Before committing check the investment charges. Most tracker funds won’t charge more than 0.5% in total and often charges can be a great deal less. Fund fees have a dramatic effect on your investments
- Use tax breaks offered from pension and Isa savings vehicles
- Invest regularly and often – preferably monthly – to lower risk. Instead of saving your cash and then investing it in one lump sum at the end of the year, it’s better to invest it at regular intervals. This is known as pound-cost averaging and helps reduce risk by averaging the price you pay for you investment over the whole year.