First, let’s agree that there’s nothing wrong with holding some cash as part of an investment portfolio.
Many advisers routinely recommend that clients hold around three to six months’ worth of salary in cash - just in case they need access to cash in a hurry. It’s important to have a secure and accessible cash buffer of this sort.
But as a long-term investment option for your money, is cash such a safe option? You may have guessed that I’m not so sure.
The problem is, many clients think it is the safest option. They are spooked by scare-stories about risky investments and low returns and discouraged by the sheer complexity of many financial instruments.
Brexit uncertainty will only add to this, and indications are that more and more people are nervously holding on to cash, seeing it as a steady option for the long-term. So why is this really not a good idea?
1. Cash is losing money in real terms
Interest rates are at an all-time low, with little sign of any upward movement on the horizon. And while inflation is similarly low, it is nonetheless present and rising – and that means cash is losing money over the long-term.
So in the most basic terms, £50 will buy you fewer cups of coffee in 10 years’ time than it can today. And this situation will only get worse if interest rates become negative – something already happening in other countries and far from impossible here.
2. It can derail estate planning
The clients who are most likely to hold large sums in cash and who see it as a kind of “safe investment” are typically those in their 50s and 60s; ideally the time when they should be thinking seriously about estate planning.
But if money is held in a cash Isa, it makes up part of the estate, so 40 per cent could disappear on death due to inheritance tax.
3. It’s effectively timing the market
When clients do invest money into the market, most advisers agree that Pound Cost Averaging is a tried and tested method of reducing exposure to falling markets.
But many clients don’t realise that when they’re holding money in cash, they’re basically ‘timing the market’; trying to predict when it’s low enough to buy or high enough to sell.
They may get the principle that timing the market isn’t a wise approach, but the chances are, they won’t make the connection and realise that their ‘safe’ cash investment is essentially doing exactly that.
4. It can waste the Isa allowance
Since the recent regulation changes to the personal savings allowance, there’s basically no real difference between a cash Isa and a normal savings account. But a lot of people tend to use a cash Isa to hold their money - which means of course that they’re basically wasting some of their tax allowance.