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.
When it comes to cash, a lot of people don’t bother to tell their advisers about the cash holdings they may have.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.
People don’t need a huge amount of financial knowledge to invest in cash, which is why many people often choose to do this DIY.
There’s a strong argument to say that, at the moment, cash is actually riskier compared to other investments. Just sounding out clients about the subject may open their eyes to an issue they haven’t thought about.
Discussing the risks of a long-term cash investment will also help them think about their overall portfolio. When it comes to cash, a lot of people don’t bother to tell their advisers about the cash holdings they may have. To give the best ‘holistic advice’, you of course, need to understand the bigger picture.
Interest rates in the UK are basically already as good as negative – at least in real terms - and there’s now a possibility that we could have negative rates for real.
In an attempt to stop their currencies rising further, negative rates are already a reality in the likes of Switzerland, Denmark and Sweden. If this was to happen here, it would simply make cash even less of an appealing option.
One more sound reason to discuss the dangers of holding large sums in cash - sooner, rather than later.
Alastair Black is head of financial planning propositions at Standard Life
