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Why hold cash? Challenges and Options for Cash Balances
With meagre saving rates, credit plentiful and an abundance of investment opportunities, this seems to be a good time to ask: what is the point of holding cash?
In this article, we share our view on this question and provide an insight into recent developments catching our attention.
Why hold cash?
As we see it, cash has two key roles in financial planning:
- Almost all of us need access to cash, in some form, to live our daily life. This includes day-to-day spending money, ‘rainy day’ reserves, and cash earmarked for a specific purpose.
- For those unable or unwilling to take an investment risk.
You will notice there is no mention of earning interest. As long as a cash deposit is not at risk of being lost, it can meet one or both of the ‘purposes’ above. The choice of deposit taker is therefore crucial. As is well known, the UK’s Financial Services Compensation Scheme (FSCS) guarantees deposits of up to £85,000 per person, per deposit taker. It is worth bearing in mind that some deposit takers use different brand names under the same FSCS limit, making it difficult to tell if this limit is being exceeded. If you are in any doubt, please refer to the FSCS website on the link provided below.
What is perhaps less well known is that if you hold a temporarily high balance as a result of specific life events, up to £1 million could be protected for a period of six months. This is intended to cover events such as the sale of your main home (although not any other property), redundancy or an inheritance.
You can find more information on the FSCS here: https://www.fscs.org.uk
What about negative interest rates?
Would the rationale for holding cash change in the unlikely event that we experienced negative interest rates? This would effectively mean deposit takers would charge for holding cash, which is already happening in some European countries.
In our view, the answer is no. The reality is that most savers already experience negative returns after adjusting for inflation. While a move to negative interest rates would, no doubt, rub salt into the wound, the core reasons for holding cash remain the same.
NS&I: Still a safe haven?
So, where is a safe place to hold cash? National Savings and Investments (NS&I) was, until very recently, a favourite home for many savers, and it remains popular. However, the recent cut in rates did not go down well, and many were left searching for the best cash rates available elsewhere.
We do, however, expect NS&I to return to favour, especially when it again becomes an attractive way for the government to help meet its funding requirements. There is much to be said for opting to redeposit maturing funds, perhaps on a one-year term, to retain ‘existing customer’ status, if the alternative is holding cash elsewhere.
One of the most appealing and unique features of NS&I is that deposits are guaranteed.
Premium Savings Bonds are also looking more attractive in the current environment. Up to £50,000 can be deposited per person, including for children. While the chance of winning is a rather modest 34,500 to 1 per £1 bond, your money is secure as you wait in hope of tax-free winnings.
What about Cash Platforms?
An interesting development over the last few years is the emergence of cash platforms. The basic idea is that an account is opened with the platform, which is then used as a ‘feeder’ into a range of other deposit taker accounts: the intention being to reduce the administrative burden of opening multiple accounts while also gaining slightly more attractive returns.
However, returns are still likely to be negative, after taking into account inflation and any charges for the service, and minimum deposit balances can be high. This remains an embryonic industry, with many new and unknown business setting up platforms. That said, these could become more mainstream over time, enabling cash to be moved from one provider to another more efficiently. If this were to happen, platforms could appeal to those with little time and who like to view everything in one place.
Final Thoughts: What is the ‘right’ level of cash to hold?
This is very much an individual decision, although an area your financial planner will be pleased to discuss with you at any time, and provide guidance specific to your own circumstances and requirements.
Our own approach factors in aspects such as your regular commitments, and the extent to which these are met by any guaranteed income, to determine a prudent cash reserve. A starting point is generally to hold two years of expenditure as cash, although this will vary according to individual circumstances.
If you hold cash in excess of what you need, after allowing for a reserve, this becomes a decision about what, if any, risk you are willing to take and your ability to withstand losses. This is a key part of any financial review.
So, while cash might be unexciting and certainly unrewarding at present, it will always have a role to play in any financial planning strategy.
If you would like to discuss how you could best hold your cash, or what to do with excess cash, please get in touch.
This communication is prepared for general circulation and is intended to provide information only. It is not intended to be construed as a solicitation for the sale of any particular investment or as investment advice and does not have regard to the specific investment objectives, financial situation, and particular needs of any person to whom it is presented. Tax treatment will depend upon individual circumstances and may be subject to change in the future.
Please also note that the value of investments, and / or the income from them, can fall as well as rise so you could get back less than you invested. The past performance of an investment should not be relied upon as a guide to its future performance. Unless indicated otherwise, comment and opinion in this publication is based on HMRC’s tax regulations for 2020/21 tax year and future proposals.
This communication has been approved and issued by Punter Southall Wealth.