Everyone thinks that cash is a safe investment. But, if you look at over 30 or 40 years, having money in a bank account is pretty disastrous for your investment return, and you could well be destroying your own financial future.
Why? One simple word: inflation.
You may have seen the recent news that the inflation rate in the UK has tripled in the last three months. As of May, it stood at a two-year high of 2.1% – above the Bank of England’s official target of 2%.
Rises in the cost of fuel and clothing are driving rises in the cost of living, alongside pent-up demand from British consumers sitting on £184 billion of lockdown savings.
A little inflation is a good thing for the economy. However, as the cost of living begins to rise sharply, it’s easy for your hard-earned wealth to devalue in real terms. Read on to find out why.
Why keeping your savings as cash is riskier than you think
Having an emergency fund is great. Everyone should have a fund of three to six months’ earnings in an easy-access account that you can get hold of quickly. You never know when you’ll encounter unexpected expenditures or need an injection of cash.
It’s also worth keeping some cash at retirement if it means you don’t have to draw down investments during a period of market volatility.
However, keeping all your money in cash to feel safe is rarely a solid long-term strategy.
According to financial analysts Moneyfacts, the highest interest rate you could have earned on an easy-access savings account at the end of June 2021 is just 0.5%. You might get a fraction more on a Cash ISA.
Compare this to the inflation rate of 2.1%.
Many people choose to leave their money in cash because it’s “safe”. They don’t want to take any risk with their savings. But, if the interest you’re earning on your money is lower than the inflation rate, isn’t that a risk in itself?
Your savings will be worth less in the future (in real terms) than they are now!
An example of the effect of inflation
If you kept £10,000 in a savings account paying 0.5% interest per annum, in 10 years’ time you’d have around £10,512.
If inflation continued at the Bank of England’s target of 2% over the next decade, something that costs £10,000 now would cost £12,189 in 2031.
Your spending power would be significantly less than it is now, just because you wanted to be safe and take no risks.
Apply that logic to a significant sum – perhaps your pension savings – and you can easily see why cash might not be king.
Your own personal inflation rate
All the above assumes that inflation stays on or around the Bank of England’s target of 2%.
But what if it’s more than that? We recently looked at the 1970s, when inflation hit double figures and living costs rose sharply.
One way to think about this is to consider what your own “personal inflation” rate might be. This measures the change in prices that represent your specific spending patterns, rather than the official inflation figures, which calculates the national average.
For example, if you do a lot of driving, the 12-month inflation rate for motor fuels is currently 17.9%. Costs of transport, restaurants, clothing, and hotels are also rising more sharply than in other sectors.
If you like travelling and eating out, then your own personal inflation rate may be higher than the UK’s 2.1% rate.
Understanding your personal inflation rate, and what you spend your money on, will influence how susceptible you are to inflation – both now and in your retirement.
We can add value here. Using sophisticated cashflow modelling software, we can create a range of forecasts using assumptions such as your personal inflation rate.
We can establish whether you’ll have enough to live the life you want to in retirement, including drawing a higher sum every year to take the effects of your own personal inflation rate into account.
Think about alternatives to cash
We’re not saying that you should move all your savings out of cash. Holding some funds in cash is important, both for emergencies and to support your income in periods of market volatility.
However, holding too much in cash is likely to have dire consequences over the long run.
A study from Barclays found that £100 invested in cash in 1899 would be worth just over £20,000 in 2019. If you’d invested the same £100 in 1899, it would have been worth around £2.7 million in 2019.
While you might not be investing for 118 years, it shows why keeping too much in cash in the long term might not be the best way to generate the return you need for the lifestyle you want.
To find out how we can create a financial plan that will meet your goals while considering your personal tolerance for risk, please get in touch. Email us at firstname.lastname@example.org or call 020 7467 2700.
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