During times of uncertainty, it can be tempting to move more of your wealth into cash. It seems “safer” due to its ability to shield from stock market volatility, and there is the security of knowing the Financial Services Compensation Scheme (FSCS) guarantees up to £85,000 of savings if your bank should fail. Yet, perhaps counter-intuitively, holding too much cash can be detrimental for your financial goals. Below, our team at WMM explain why cash should form a relatively small portion of most people’s longer-term wealth compared to their other assets.
Cash is not risk-free
On your bank statements, cash savings may seem to be earning you money. However, inflation is usually eroding their real value. In 2022, inflation currently stands at 10.1%, meaning it may now cost you £1.10 to buy an item that cost you £1 twelve months ago. If your cash savings offered you a 10.1% interest rate, then they would be closer in keeping up with this rising living cost. However, interest rates remain low, with the “best” deals currently offering 1.85% easy access and 3.61% fixed.
Cash, therefore, is not risk-free. In fact, you are certain to lose value over the long term due to inflation. This makes it a poor asset class for building long-term wealth. Cash can certainly help provide an easy-access emergency fund (e.g. 3-6 months’ worth of living costs) if you come across hard times, such as losing your job. It can also be useful when building towards a short-term financial goal (e.g. putting down a mortgage deposit within the next three years). However, if you want to build a retirement fund and stand a chance of beating inflation, other assets need to be considered for your portfolio.
Alternatives to cash for building long-term wealth
Non-cash assets such as bonds, equities and property can intimidate people. After all, they often involve more volatility. Stock prices can go dramatically up and down within a day, and the housing market is also subject to fluctuation. Yet it is worth pointing out that nobody can completely escape risk. Even the value of cash changes due to currency exchange movements. If the pound (GBP) devalues, then it can result in higher prices for UK consumers. A 20% fall, for instance, can lead to prices of imported goods rising by 25%.
One key aspect to building wealth, therefore, is to try to balance the risk associated with each asset class – helping you to also benefit from their opportunities. You can build a portfolio that reflects your unique “risk appetite” too, with the help of a financial planner. If you are a “cautious” investor, then leaning your portfolio towards investment-grade bonds may be appropriate. Those with a longer investment horizon and higher risk tolerance, conversely, are likely to do better by including a higher proportion of equities within their asset mix. The FTSE 100, for instance, has averaged a 7.75% annual return since its inception in 1984 – despite numerous economic crises and market falls along the way. Property has also historically shown itself to be a strong investment over the long–term. UK house prices in 2022 are 65 times higher than they were in 1970.
With this said, building an effective and diversified portfolio is no simple task. There are 1,000s of funds available in the UK market alone. Getting help from an experienced financial planner can help you narrow down on a shortlist of appropriate investment candidates in light of your goals, risk tolerance, investment horizon and sound principles (e.g. the fundamentals of a prospective investment). Over time, your planner can also help keep your portfolio on track and aligned with your chosen investment strategy.
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This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult us here at WMM (financial planning in Oxfordshire).
