Cash is (sometimes) king

interest rates within cash deposit funds are still really low, with no immediate prospect of any significant change. Investors could be forgiven for thinking that it is pointless to hold any amount of money in cash accounts. Inflation (the increase in prices of goods) is hovering at around 2% or 3%, and therefore the rates available for easy access cash accounts are guaranteeing a loss of purchasing power. If the interest rate is less than the rate of inflation, the purchasing power of the money in the cash deposit account has reduced. This isn’t a great outcome and is the reason why investors place money into stock markets, ie to achieve a medium to long-term return that is higher than the rate of inflation.

Why bother with cash deposit accounts?

However, one of the main objectives of any financial plan should be to have the right amount of money available at the right time. For anything that is required in the next two or three years, the only rational home for this money is in a cash deposit account. It doesn’t really matter what the rate of return is – all that matters is that the money is secure and available. Although the long-term outcome will be absolutely fine, depending on the level of risk being taken, an investment portfolio will suffer occasional temporary declines of anything up to 40% or 50%. This would be pretty disastrous if the money was required immediately.

So, how much should you hold in cash deposit accounts?

One element of your financial plan should be to look at expected income versus expected expenditure over the next two or three years and work out any shortfalls. This should include not only any regular expenditure but also any one-off capital sums that may be required. Even if there are no foreseeable income shortfalls, some kind of a sensible cash contingency fund is still a good idea for unexpected events. This is more art than science, but the main point is that not having any kind of a cash contingency fund is definitely a risk. At the time of writing, easy access accounts are available that pay up to 1.5% per annum and, for cash that may be required in the next two or three years but not immediately, one year fixed rates of around 2% are available. Not disastrous if you compare this to the risk of investments falling in value in the short term. Although your investment portfolio will be the engine behind your financial plan, cash is sometimes king.

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