This reflects the belief by some that cash is more valuable than any other form of savings or investments. Having a healthy cash cushion is usually a good idea, but understanding the real value and potential downsides of holding onto cash is crucial.
Those who want a cash cushion may opt to save money in bank accounts or cash ISAs (Individual Savings Accounts). A bank current account will usually pay a very low level of interest, while putting it in a savings account or cash ISA for a year or more may attract a higher rate.
Why inflation matters
With interest rates currently very low, you may find that none of these options get a return high enough to beat inflation, effectively reducing the real value of your savings over time.
Inflation, otherwise known as the increase in the cost of living, currently stands at 1.7% (in October 2019). That means for each £100 you’ve spent before, the same things will now cost you £101.70.
So when it comes to saving and investing, inflation matters. If you’re earning 1% interest on your cash savings then after a year your £100 will be worth £101. But if inflation is ticking along at 1.7%, the cost of what you buy will have gone up at a faster rate than the interest you’re earning.
This is what we mean by a reduction in real value. And while the sums involved in this example may seem insignificant, it can have a ravaging effect on your savings over many years.
And that’s important.
Growing your money
Leaving your money in cash savings over the long-term may not be the best way to reach your financial goals. The Financial Conduct Authority – the UK’s main financial regulator – has already expressed concerns about this, particularly when it comes to the money people need to live on in retirement.
Some people in retirement have most of their money in cash savings, but don’t appear to have any immediate need for it, meaning its value will start to erode over time.
They might need to consider keeping at least some of their money invested in assets with potential for growth, such as stocks and shares, though those can go down as well as up in value. That way they have more of a chance of outpacing inflation.
Of course, none of this means having some of your money in cash savings is necessarily a bad thing to do. Where you need immediate access to it and you want to protect it from short-term falls in value, it’s an entirely reasonable option.
Plus, it’s also a good idea to always have a cash buffer in case of emergencies.
Whether it’s an unexpected expense or riding out investment market ups and downs, having extra cash to hand can definitely come in handy at certain times.
The thing to remember is when you invest your money for the long-term, you’re giving it a chance to grow, although you have to be prepared for volatility and it could go down as well as up in value. There’s no guidebook to tell us where or how much and when to invest our money. There are no guarantees but, ultimately, the longer you leave it invested, the better your chances are of seeing it grow and giving you better returns.
On a very small scale, I save cash for my son. I put any spare coins I have in my pocket each day into a piggy bank.
The piggy bank doesn’t earn any interest, but given that Arlo is only one year old, he has an extraordinarily long time horizon to get saving.
So I’d better get those savings working somewhere soon or they could lose value when you take inflation into account. Who knows, perhaps coins won’t even be legal tender by the time he needs them!
Find out more in What’s in an ISA?
The information here is based on our understanding in October 2019 and should not be taken as financial advice. Views expressed are the writer’s own.
The value of investments, including Stocks and Shares ISAs, can go down as well as up and they may be worth less than was paid in.