Brits have been hoarding billions in cash since lockdown started, according to the Bank of England, and most of this money is languishing in savings accounts that don't even keep up with inflation. We’re not big fans of holding cash at Morningstar, and certainly not for the long-term, but it is sensible to have some cash to hand in case of an emergency, or to keep some powder dry to invest if an opportunity arises.
Cash clearly holds a certain appeal for savers. Most recent HMRC data shows that three times the number of Cash Isas were opened than Stocks & Shares Isa. The same pattern can be seen in Junior Isas. So, what are the pros and cons of holding cash?
5 Reasons to Hold Cash
1. Cash can be saved for short-term goals
Whether paying university fees or a putting a deposit for a house, it's reassuring to know that your money is safe, especially if these obligations are due soon. Experts tend to say you shouldn't invest unless you know you won't need the money for at least five years, so while investing is great for long-term goals such as retirement, if you're saving for something in the near future, it's better not to take the risk.
2. Cash is useful for unexpected expenses
Boilers and cars have a habit of going wrong in the winter months, for example, and you don't want to have to sell your investments to pay for these. Experts typically recommend having three-to-six months' worth of expenses in cash as an emergency or rainy day fund.
3. Having cash stops you borrowing money
Credit is easy to come by but hard to get rid of. The money you spend paying off credit cards or loans every month could be spent putting money in your pension or investing. Having a cash buffer can help you avoid resorting to debt if an unexpected expense comes your way.
4. Cash is a comfort in hard times
For the worst affected employees in this economic downturn, having a buffer can pay the bills until you get another job. Instant access savings make this much easier.
5. Cash can help with asset allocation
While it shouldn’t be a major part of your portfolio, cash can provide protection in market volatility and can be put to work to pick up assets on the cheap after a stock market fall. No assets provide 100% capital protection but cash is about as steady as it gets - the only issue is it loses value in real terms as it doesn't grow enough to keep up with inflation.
5 Reasons to Ditch Cash
1. Inflation and Interest Rates
Most savings accounts cannot keep up with the cost of living and £10,000 in 10 years will be worth a lot less in real terms than it is today, especially if you’re only getting 0.1% a year in interest.
2. Performance
Equities can be volatile – and they were shockingly so in March 2020 – but their long-term outperformance over bonds and cash is hard to argue with.
3. Timing the market is almost impossible
Every investor wishes they had sold shares at the top and bought at the bottom, but even the professionals can’t manage this. While you might be holding cash in the hope that you can deploy it into the stock market at the perfect moment, the chances are you won't.
4. The tax benefits are very limited
The biggest appeal of Isas is that any gains you make are tax-free, but how worthwhile is that when we're talking about cash? Research from Janus Henderson shows the average Cash Isa will pay £47 in interest in a tax year, providing measly tax relief of around £9. Some of the highest yielding investment trusts, in contrast, would provide tax relief on dividends of more than £300 a year.
5. You can use your savings allowance instead
If you want to shield your cash savings from the taxman, don't forget you also get a £1,000 savings allowance (£500 if you’re a higher rate tax payer) on top of your Isa allowance. This £1,000 is for interest earned, not the amount saved. At current interest rates, for most people that’s a generous allowance – with interest of 0.1% you’d need a savings pot of £1 million to generate £1,000 a year in interest. If you think that magic million is enough to retire on, we’ve run the numbers for you.
