Long ReadFeb 22 2022

The importance of cash in spite of inflation

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The importance of cash in spite of inflation
Credit: TOLGA AKMEN/AFP via Getty Images

It is well established that inflation can erode the real value of cash savings, but the latest inflation figure, having reached a 30-year high, makes this fact acute.

The highest rate available on an instant access savings account was 0.71 per cent on February 16, according to comparison site Moneyfacts. A year ago, the highest was 0.6 per cent. Two years ago, it was 1.34 per cent.

Meanwhile, CPI rose by 5.5 per cent in the 12 months to January, up from 5.4 per cent in December.

“While the Bank of England predicts such a level [of inflation] to be temporary, even the government target of 2 per cent cannot be beaten unless savers lock into a five-year fixed bond,” observes Rachel Springall, finance expert at Moneyfacts.

“There are still savers out there waiting for the December base rate rise to be passed onto them, let alone the most recent uplift of 0.25 per cent a couple of weeks ago.”

How inflation can reduce the value of £100 in cash savings

Given the real losses of deposit returns when compared to inflation, Colin Dyer, client director at Abrdn Financial Planning, says the company has seen some examples of clients who would have traditionally found security in having large cash balances alongside their portfolio reducing the scale of cash holdings.

Taking stock of cash

With the potential for cash to lose its purchasing power, Bradley Russell, senior investment manager at Brewin Dolphin, says: “This is why we always ensure clients are holding ‘enough’ cash, but warn against holding too much. Now, in truth, what constitutes ‘too much’ is entirely down to personal preference.

“But the threat of inflation is very real and this is causing many clients to take stock of their overall cash holdings and look elsewhere, most notably to assets that typically appreciate in value over time and therefore combat inflation to some extent.”

Russell adds that some clients who hold large amounts of cash have accepted that their funds will depreciate, in real terms, at around 2 per cent a year.

“But [they] are happy with this, particularly as inflation has been so low over recent years. But suddenly, 5, 6 or 7 per cent feels a lot more real, so again this is driving people towards investment.”

Alex Hatfield, partner at The Private Office, also says clients are starting to focus more on how inflation affects their current spending power, as well as the future impact it might have on savings, investments and pensions.

“We have had such a benign inflationary outlook for so long that many people have forgotten the damaging effects of inflation and an environment of high interest rates. I am not sure that a great reassessment has begun, but certainly concern is rising.”

Although inflation is on the rise, Hatfield adds that this does not mean clients should not hold cash on deposit, despite its current unprofitability.

“Nothing does what cash does. It provides access in an emergency, helps one sleep well at night, and stops an investor being a forced seller in a bad market. It buys time and peace of mind.

“In general, we like clients to retain cash deposits for known expenditures, peace of mind, and contingencies. Once we feel that is covered, then cash has a limited part to play.

“And for clients who are accumulating their wealth over the longer term, inflation today is less of a problem, assuming it is transitory.”

The clients with limited concerns

Stewart Sanderson, senior private client director at Brooks Macdonald, says the company's clients are generally focused on making sure that their cash is “working”, regardless of the macro environment.

“Allocations to cash are often for a set purpose, such as to top up income, a planned house renovation or similar expense.”

Mike Stimpson, partner at Saltus, also says that with rates at historical lows for so long, most of his business's clients do not hold significant proportions of their assets in cash.

Instead, many have investments in real assets that tend to be less affected due to physical limits on their supply, such as property and gold.

“Anyone who owns property will know of the long running ability of that asset class to grow returns above the general rate of price increases, while commodities also have long track records of usually, but not always, outperforming in inflationary environments.”

Hatfield says clients are showing greater awareness that investing in good quality companies and real assets has the prospect of beating inflation.

“Those investments participate in the real economy. Cash, unfortunately, does not.”

But Hatfield adds that the business is wary of clients "over-investing".

“While inflation might be more of an issue now than normal, so is market volatility. 

“As clients transition from accumulating their wealth during their working lifetimes to decumulating their wealth in retirement, cash has such an important part to play – as a short-term store of spending money, and to help people ride out market difficulties, preventing them from having to access money from investments at an inopportune time.”

Chloe Cheung is a features writer at FTAdviser