Your Money - Your Future
Why Cash is Not Necessarily KingBack to News & Views
The pandemic has caused financial hardship for many people, with multiple industries still facing uncertainty.
But for those fortunate enough to stay in work, or be covered under the furlough scheme, there have been fewer opportunities to spend money. Long, sociable lunches, after work drinks and foreign holidays have been off the menu for over a year. While many of us might have splashed out on new tech, home improvements and leisurewear, the savings still add up.
As the economy starts to open up again, the temptation is to shop, eat, drink, travel, and generally make up for lost time.
But if you do have some extra cash in the bank, why not take some time to plan for the future, rather than falling into old spending habits?
Why You Should Hold Cash
It’s always a good idea to hold some cash. It’s easy to access and the value doesn’t fluctuate. Even speculative investors should keep some cash aside, split into the following main categories:
It’s common sense that you should have enough money in the bank to cover your expenses until the next pay day. But this is sometimes easier said than done.
To budget effectively, you will need to have an idea of your income and expenses every month. It is only then that you can work out your surplus, which you can then use for other purposes.
It can be useful to hold at least three separate accounts, for example, bills, shopping, and fun money. This means that you have a limited amount to spend on discretionary items and your essentials will be covered.
You should also make sure you have at least 3-6 months’ expenditure set aside for emergencies.
This means that if you have an unexpected bill or a short period out of work, you can cover your costs without going into debt, or dipping into investments intended for other purposes.
It’s important to keep aside cash to cover any short term spending, for example holidays, home improvements, or gifts.
If you are reliant on pension or investment withdrawals to cover your expenditure, you should also aim to keep a cash buffer within your investment allocation. This means that your investments have more time to grow and you can encash when you are ready, rather than being forced to sell during a downturn.
Any sensible investment strategy should include a plan for cash.
When is Cash Not the Best Option?
Once your cash reserves are fully funded, how much cash do you really need to keep?
The answer will depend on your situation, but there are several reasons not to keep excessive amounts on deposit:
- Interest rates are currently at an historic low point.
- The cost of living rises every year. If your capital isn’t growing by the same amount, you are actually losing money in real terms.
- Bank deposits are protected by the Financial Services Compensation Scheme, up to a limit of £85,000 per person, per banking group. So if you hold more than £85,000, at the very least, you should consider spreading it across more than one banking group.
Cash is not the ideal asset class for large amounts of money that are likely to be held for the long term.
If you have surplus cash that you aren’t going to need for at least five years, you might want to consider some other options.
What to Do with Your Surplus Cash
Spending it would be the obvious answer, but there are a few things you can do that would actually improve your financial situation in the longer term.
If you have expensive consumer debt, such as loans or credit cards, you will save significant amounts of interest by clearing the balance early. Once your cash reserves are fully topped up, repaying higher-interest debt should be a high priority.
If you are considering repaying your mortgage, weigh up the options carefully. Mortgages tend to have competitive interest rates, and they are secured against an asset that will hopefully grow in value. If you are prepared to take some risk, investing the money could improve your longer-term position. However, there are no guarantees, and if you prefer to deal in certainties, reducing your mortgage could be a good use of your surplus cash.
Investing in Property
Property is a popular investment, for many reasons. Most investors have dealt with property at some point, and may feel like it is easier to understand than the stock market. It has a tangible value, and few other investments allow you to fund your purchase through borrowing.
But before you use your hard-earned savings to put down a deposit on a buy-to-let, bear in mind the following:
- If you already own a residential property, a stamp duty surcharge will apply in most cases. This is 3% in England and Northern Ireland and 4% in Scotland and Wales, on top of the standard rates.
- Property is illiquid and difficult to sell.
- Historically, equities have outperformed property.
- It is also easier to reinvest your dividends to buy more shares. Using rental income to buy more property takes a lot longer.
- Managing a property incurs costs and administration.
- While you can claim tax relief against mortgage interest, this is capped at the basic rate.
The Benefits of a Diversified Portfolio
Alternatively, you may prefer to invest the money in your ISA, pension, or other investment vehicle.
You should only consider this if you are prepared to leave the money invested for a minimum of five years, ideally longer. In the case of a pension, you won’t be able to access the money until at least age 55.
The investment options in today’s market are virtually endless. It can be tempting to follow trends and put all your money in hot stocks and cryptocurrency. But doing this risks heavy losses, and is more closely related to gambling than financial planning.
A sensible investment strategy has the following features:
- It holds a wide range of assets. This allows you to benefit from market growth, while smoothing out the worst of the volatility.
- It invests for the long term.
- It avoids trying to time the market or achieve quick wins.
- It keeps costs under control.
- It takes an appropriate amount of risk for the goals and circumstances of the investor.
Please don’t hesitate to contact a member of the team to find out more about your investment options.
The value of investments can fall as well as rise. You may not get back what you invest.