4 Ways We Use Cash In Our Financial Planning Strategies

With the rise in the Bank of England Base Rate over the last 12 months or so from 0.50% in February 2022 to 4.50% in May this year, we have seen many banks and building societies introduce a range of savings accounts paying attractive rates of interest.

A quick look at any comparison site will show you which institutions are paying the most attractive rates and it is possible to find a One or Two Year Fixed Rate Bond at close to 5.0% and Deposit Accounts paying interest at over 3.5%

Many banks are trying to attract customers to switch current accounts by offering incentives such as a cash bonus and a high interest rate if a certain amount is paid in each month.

Irrespective of the interest rates on offer, it still pays to do some research and you should take into account:

Financial Services Compensation Scheme (FSCS)

Is the bank or building society covered by the Financial Services Compensation Scheme (FSCS)? This will cover up to £85,000 of the cash balance for single accounts or up to £170,000 for joint accounts.

These limits will apply to banks and building societies who have their own banking licenses so, where you have more than £85,000 spread across several financial institutions, you should check whether they share the same banking license. This can be done via the FSCS website.

For example, Lloyds Bank and Scottish Widows share the same banking license.

Temporary High Balances

The FSCS will protect certain qualifying temporary high balances up to £1m for six months from when the amount was first deposited. This is designed to reflect the fact that certain life events could have caused a temporary high balance in your bank account. For example:

Sale of your main residence.
Benefit paid under an insurance policy.
Financial settlement following divorce.
Benefits payable on retirement.
An inheritance.

There may be other occasions when you might have a temporary high balance and the FSCS may ask for proof if a compensation claim is made.

Terms and Conditions

You should always check the terms and conditions carefully before applying for an account especially if you are looking to tie your money up for a period of time. For example, some accounts will allow one or two withdrawals a year without penalty whereas some will not allow you to withdraw money until the end of the term.

Another thing to check is what happens at the end of the term. Although banks and building societies will write to you before the end of a fixed term, if you don’t respond sometimes you might find your money automatically rolled over into a new fixed term deposit. This can be problematic if you need the money and can’t get access to it. Alternatively, you might find you are placed in an account paying no interest. It therefore pays to make a note of when any fixed term deposit comes to an end.

Some current account deals may involve paying in a set amount each month or retaining a certain balance and failure to do this could mean you don’t qualify for the higher rate of interest or the cash bonus.

National Savings and Investments (NS&I)

Where you are holding a significant balance for a long period of time, National Savings and Investments (NS&I) could be an attractive alternative to using a bank or building society. This is because they are backed by HM Treasury and will secure 100% of your savings.

They offer a range of savings products and although the rates of interest are not the highest available, they are still reasonably competitive. They also offer the opportunity to save into Premium Bonds which offer the potential to win £1m.

Disadvantages of Holding Cash For Long Periods

The main disadvantage of holding cash is that interest rates will tend to lag behind inflation. This means that, whilst your capital remains secure, it’s purchasing power is being eroded by inflation. This is known as inflation risk.

All investments come with a degree of risk but if you are investing for the long term it makes sense to consider investments that offer the prospect of a return in excess of inflation.

How We Use Cash In Our Financial Planning Strategies

We believe that cash can play an important part in a client’s financial planning strategy and there are typically four ways we use cash.

#1 - As an Emergency Cash Fund

We always suggest that clients hold an emergency cash fund to meet any unforeseen emergencies. Typically this will amount to three to six months’ worth of expenditure although some clients like the reassurance of holding more than this.

#2 - To Meet a Short-Term Savings Goal

If a client has a capital expense in the next couple of years, we will typically hold this in cash. For example, a house purchase, a daughter’s wedding or other significant expense where the cost is largely known. If this money were invested, there is the risk that the capital value may have fallen at the time when it is required.

# 3 - As Part of a Decumulation Strategy

Typically at retirement, clients will look to take an income from their accumulated capital and there are a number of risks that need to be managed at this time especially when investment markets are volatile. Taking an income from accumulated capital when markets are falling can put pressure on the underlying investment funds. As such, we may consider holding sufficient cash to pay, say, a couple of years’ worth of income to weather any extreme volatility.

#4 - To Pay Fees and Charges

Most of our clients will hold their pensions and investments on an investment platform and there will be a cost for this. Most of our clients also prefer that our fees are taken from their underlying portfolio. We will normally hold between 1 – 2% of a portfolio in cash to cover any fees and charges.

Conclusion

All of our clients are unique and there may be times when holding cash is the best option for a client in helping them to achieve their financial planning goals.

However, over the longer term, holding significant amounts in cash could be detrimental and evidence suggests investing cash into a well-diversified investment portfolio and accepting a degree of investment risk will produce superior returns over the longer term.

Contact Us

If you are holding significant cash balances and would like to discuss how best to invest this, please do contact us using the button below.