Is Cash Still King?

With investment portfolios moving sideways over the last couple of years or so and with interest rates rising, many people are looking to cash as a relatively safe way to capture investment returns.

In this article, we look at why cash isn’t a suitable long-term asset class to grow wealth and how cash could be used instead.

Cash Over the Long Term

The key risk that impacts your cash holdings is inflation. Generally speaking, the rate of interest received on cash is not sufficient to keep pace with inflation.

Currently (as at September 2023), the rate of inflation as measured by the Retail Prices Index (RPI) is 8.9% and the rate of inflation measured by the Consumer Prices Index (CPI) is 6.3%. The main differences between the two is that RPI takes into account housing costs and council tax whereas CPI does not. They are also calculated using two different methods, one uses an arithmetic mean and one uses a geometric mean.

Over the long term, your cash holding will therefore be eroded by inflation.

The following graph looks at three indices over the past 20 years:

The MSCI World Index – a globally diversified index of company shares.
UK RPI – a measure of inflation.
The Moneyfacts 90 Days Notice Index which is a proxy for cash.

The graph shows what would happen if you invested £100,000 into these three indices over the last 20 years.

As you can see, over the last 20 years cash has underperformed inflation by a significant amount. However, the MSCI World Index has significantly outperformed both cash and inflation over the same period.

Although we have seen relatively low interest rates and low inflation during this period, it should be noted that we have also seen a global credit crisis, a pandemic as well as numerous conflicts, trade wars and political crises which have all impacted investment markets.

Investing in global equities does carry a degree of investment risk and investors will have seen significant short-term falls within the last 20 years. Despite this, global equities have tended to provide a long-term return over and above the rate of inflation.

Most people will adopt a middle ground whereby they will introduce other asset classes into the portfolio to try and dampen down the volatility associated with equities. The extent to which this is done will be linked to discussions around your views on risk.

Where does Cash Fit In?

Cash can play an important role in your finances and much depends on your financial situation. The following scenarios show how we might use cash as part of a client’s financial plan.

Emergency Cash – all clients should have access to an emergency cash pot and this could be between three and six months’ worth of expenditure. As they get older and move towards retirement many clients feel more comfortable holding more cash.

Short-term Goals – typically, these are goals whereby a cash sum is required in the next five years. For example, if you are planning to buy a house in the next couple of years and you have saved some money for a deposit, you won’t want to see the capital value of your deposit fall. Similarly, if you are looking to pay for an expensive holiday, a new car or building work on the house, it make sense to hold this in cash.

Income Needs – When clients reach retirement and they want to turn on an income from their capital, there needs to be a balance between growing capital and providing income. Most people are not in final salary schemes anymore and many people don’t like the idea of buying an annuity. As such, a common strategy is to hold, say, two years’ worth of income in cash in order to ride out the fluctuations in investment markets. One of the risks facing clients in retirement is withdrawing capital in a falling market – also known as pound cost ravaging!

What To Look For When Researching Cash Accounts?

There are a number of accounts paying attractive rates of interest at the current time and, generally speaking, you should consider the following when depositing cash:

How safe is your money – if you have a significant amount to invest and more than £85,000 which is covered by the Financial Services Compensation Scheme (FSCS), you might want to split the money across different providers with different banking licenses or consider using National Savings & Investments which is backed by the UK Treasury.

How Long Can You Tie The Money Up – generally speaking the longer you can tie your money up, the better the interest rate. For example, a three year fixed rate deposit will tend to pay a better interest rate than an instant access account. However, in most cases, you will not be able to access your money within the time period of the fixed term deposit.

Terms & Conditions – you should always read the terms and conditions carefully before depositing any money.

Some providers offering deposit accounts with attractive interest rates will insist that you open a current account with them.
Some providers offer a really good introductory rate for, say, 12 months after which the interest rate falls dramatically.
Some accounts may be internet only which may be a concern for those who want to open and operate their account in person.
For fixed term deposit accounts, some banks and building societies automatically roll over their account to a new account with the same term if you don’t request to withdrawal your money at maturity.

Conclusion

Cash certainly is king in order to provide an emergency cash buffer, to meet short-term goals and to provide an income, however, it is not the key to long-term wealth creation. For that, you need to accept an element of investment risk and look for a portfolio that can achieve a rate of return in excess of inflation.

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