Rising interest rates, growing uncertainty, and heightened volatility in other asset classes such as equities have all contributed to the recent allure of cash; Tim Bennett breaks down some reasons why might want to hold some cash as well as putting forward reasons why holding too much might not be an optimal strategy in the era of high inflation.

 
Cash is king, or so the old saying would suggest. However, in these uncertain times and as economic conditions evolve, how much should investors be holding and what are the alternatives?  

Rising interest rates, growing uncertainty, and heightened volatility in other asset classes such as equities have all contributed to the allure of cash. Nonetheless, there are some good reasons to not keep excessive amounts of it for extended periods. Tim Bennett, Head of Education at Killik & Co explains why.

 

Reasons to hold cash as part of a long-term strategy

 
As an asset class, cash can play a vital role in certain circumstances. Investors should consider it for the following purposes: 
 

  • Rainy-day buffer: Cash can serve as a safety net for unexpected expenses or emergencies. And it can be seen as a relatively safe haven for money in an uncertain climate. So, how much is enough? A rainy-day fund of roughly 3-6 months of your monthly spending (gross) if you are single or in a couple, and more like 6-12 months if you are responsible for a family should normally suffice, depending on your personal circumstances and risk attitude.  
  • Seizing opportunities: Keeping some cash on hand can also mean you are able to exploit investment opportunities as they arise. For example, should you spot a good entry point for individual shares or funds, having a cash reserve on hand will allow you to take advantage.  
  • Mitigating uncertainty: Cash can help reduce the overall risk level of a portfolio. This may be more of a priority the post-work phase of someone’s life. A higher allocation can create a low-risk income stream as part of a wider strategy.  
 

The problem with cash: inflation

 
Despite these advantages, there is a significant drawback to holding cash, even when interest rates are high – inflation. The absence of any capital gain means that investors rely solely on the income generated from it. Unfortunately, cash returns often lag the rate of inflation, something we have seen over the past 12 months in most cases. 

Longer-term, the impact can be devastating.  Consider an individual who stashed £100 under their mattress in the early 1970s and retrieved it today. While it will still look like the same £100, its purchasing power will have dwindled significantly to the point where it will now only buy around £7 worth of goods and services. This erosion in purchasing power is a direct consequence of inflation.  
 

Maximising a cash strategy

 
In order to balance the merits of cash against the pernicious impact of inflation, careful planning is essential. Here are some closing thoughts; 

  1. Determine the appropriate cash allocation: Work out systematically and unemotionally the amount of cash you need to hold following my earlier guidelines. 
  1. Diversify cash holdings: Spread significant cash amounts across different institutions to avoid exceeding the Financial Services Compensation Scheme (FSCS) limit of £85,000, in the (relatively unlikely) event that a provider fails. 
  1. Explore Alternatives: Consider investing shorter-term capital in government bonds (gilts), which can provide competitive returns and offer certain tax advantages. Given that the bond market comes with its own quirks and jargon, and is not open to private investors directly, it is worth seeking expert advice first. 
  1. Seize Opportunities: Should the stock market dip, consider taking advantage of the buying opportunities that may arise. Whilst this can seem counterintuitive at the time, you may thank yourself for being brave in the future.  
 
Overall, given that the size of a cash “comfort blanket” is such an important and personal subject, consider talking it through with an Adviser so that you strike the right balance between risk and reward when it comes to your lifetime planning strategy.
 

Tim Bennett is Head of Education and Partner at Killik & Co
 



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