Cash can play a critical role in realising your financial and life goals – but it needs to be seen as part of a broader wealth plan.
Whenever there is financial, economic or political uncertainty, investors can often consider whether they should move some of their assets into classes traditionally seen as “safer” – the primary one being cash.
While such thinking may be understandable when the financial picture is turbulent, it’s always best to avoid emotionally charged decisions when managing money and investments.
When it comes to cash, in particular, there isn’t one single answer to the question, “How much should I hold?” As with any wealth-planning decision, the key is to take a step back and look at the bigger picture: the balance between the assets you hold and how this aligns with your short-, mid- and long-term goals, your age, tolerance to risk and existing investment portfolio choices will all come into play.
At the simplest level, cash holdings typically include savings accounts and deposit accounts such as fixed-term deposits, and premium bonds.
“When thinking about cash, it’s important to consider liquidity,” explains Chris Wilson, director – Investment Counsellors at RBC Wealth Management in the British Isles. “Cash assets are something you would usually want to be able to access pretty quickly for whatever reason. However, not all cash holdings can be accessed instantly, or they may come with a penalty for doing so.”
It’s also important to note that while liquid assets usually come with lower risk and lower returns, that doesn’t mean there is zero risk. “For example, a bond market can be very liquid, but you could be forced to sell a bond at a time when the market is down,” says Wilson. “So, we would deem that as riskier than something like a savings account or a fixed-term deposit.”
Perhaps the most important question to start with is not “How much cash should I hold?” but “What are my financial goals?” Once you have worked out what those objectives are, you can better determine what to do with your assets, including cash, and what your risk profile is.
Individuals could consider segregating their wealth planning into multiple investment objectives, such as retirement planning, paying for children’s (or grandchildren’s) school or university fees, investing in a business, buying or renovating a home and providing for family after death.
These goals will likely require different investment approaches. In some instances, it makes sense to tie funds up for the long term, whereas others may need more liquidity.
“When it comes to working out how much cash to hold, a useful starting point is to break it down into planned and unplanned expenses,” says Nick Ritchie, senior director of Wealth Planning at RBC Wealth Management in the British Isles. “Planned expenses could include the basic costs of running a home and going on holiday. These expenditures could be paid for by a regular income, for those who are still earning, or come out of cash reserves, for those who aren’t.”
He adds: “Then there are planned larger capital expenses, such as home renovations or a new car, which could happen in the next few years and can’t be paid for from income alone. If this is in a three-to-five-year time horizon, it may be worth retaining that in cash and keeping it relatively accessible.”
More unpredictable, of course, are the unplanned expenses, such as unexpected tax bills, home repairs or a change in professional circumstances – and it’s here that investors will need to look at cash-flow management to establish their “rainy day” fund. “This is personal to the individual,” says Ritchie. “But we might say to retain six-to-12 months’ worth of expenditure, so that if someone doesn’t want to be forced to access their investments, they’ve got readily available capital.”
The amount of ready capital will vary from one person to another. For private equity professionals, for instance, who may receive capital calls, the fund would likely be much larger. “By anticipating liquidity demands, the more likely someone will be able to avoid becoming a forced seller of investments,” explains Ritchie. “Not least because this can potentially crystallise a loss.”
“When times are uncertain, investors may want to hold on to cash until markets pick up or there is less volatility,” says Wilson. “But the problem with trying to ‘time’ the market like this is they could miss the boat. Higher interest rates can complicate the picture slightly, in that some investors may feel it is sensible to keep cash destined for inevitable investments in savings, rather than long-term assets such as equities. But as history continues to show, the markets typically outperform cash in the longer term .”
Ultimately, deciding how much cash to hold depends on what you need it for. The following factors can help with your decision-making:
Other considerations when thinking about cash are external factors such as inflation and any tax implications. In a high-inflation environment, for example, are any gains from interest being eroded, and does this need addressing?
Regarding tax, if an individual is a higher-rate taxpayer, then any interest received may well be liable for tax at 45 percent. So, it’s important to consider mitigating this by using the annual cash ISA allowance of £20,000 or products such as premium bonds, in which returns are tax-free.
Cash is just one asset you can use as part of a diversified approach to investing. A 2023 RBC Wealth Management survey of 600 British high-net-worth individuals (HNWIs) showed that 72 percent need some form of guidance on investment management, and 86 percent of 25-to-54-year-old high-net-worth individuals need direction on how to diversify the ways in which their assets are held.
Be it during turbulent times, after a liquidity event, or when the markets are more stable, the need for ongoing wealth-planning advice can’t be understated if you are to achieve your financial goals, whatever the time frames may be.
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