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Why you should hold some cash despite the return of inflation

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14/11/2016
First paltry interest rates, now rising inflation. It's no wonder savers are increasingly looking to move their money into investments. But if they do, here's why they should keep at least some cash aside.

There hasn’t been much positive news for Britain’s savers in recent years. Rock bottom interest rates mean it’s been an uphill struggle to make any return on your cash.

Now with inflation returning to the fold, things have gone from bad to worse.

The UK’s headline rate of inflation – measured by the consumer price index (CPI) – reached 1% in September up from the previous month’s 0.6%, taking it to its highest level in almost two years.

It is expected to continue its upward trajectory, with the Bank of England forecasting it to reach 2.7% next year.

Why is this bad news for savers?

This is bad for our piggy banks because inflation has a big eroding effect on the value of our cash. As prices rise the amount of goods and services we can buy with our cash falls, so the value or spending power of our savings falls.

“The only way to avoid this or reduce the impact of inflation is to earn interest on the cash savings or invest it in assets which could grow faster than the rate of inflation,” says Adrian Lowcock, investment director at Architas.

As we know, the imploding savings market has made earning interest on cash products a thankless task.

The average interest rate available on an easy access current account is 0.55%, according to rate watcher Savings Champion, and some are paying as little as 0.01%.

Moving savings into investments could be the order of the day – if you’re happy to take on the associated risk.

But before you put all your disposable income into the stock market, it’s worth holding onto some cash – despite the imminent threat of inflation.

For emergency or short term expenditure

It may sound obvious but keeping a bit of cash for unexpected outlays is a good idea. Whether it’s to replace the boiler or pay a bill, cash is flexible and accessible.

Lowcock says the key with accessibility isn’t how quickly you can get the money, but what the value will be when you do. “With cash it is not going to drop in value, but an investment could be worth a lot more or less than you expect if you need it in an emergency.”

You also have some certainty with cash. £10,000 will still be £10,000 tomorrow or next week. This certainty doesn’t exist with investments.

How much cash? The recommended ‘rainy day’ fund is three months.

In retirement

If you have retired, it’s worth keeping a good chunk of your money in cash. Lowcock says “perhaps a couple of years”.

“When you are retired you need to draw on your investments for income, but having two years or so of income means you are not forced to sell an investment at short notice, which could be bad timing.”

How much cash? Two years’ worth

For tactical moves

The other benefit of having some cash set aside is that you’re ready to invest when you spot an opportunity, whether that is from a market fall such as the one we saw after the Brexit vote, or a new stock market float.

Lowcock recommends having 5-10% of your portfolio in cash.

“If you have too much in cash, the danger is you become less rational and panic if you have missed an opportunity. You then put your money to work when you really shouldn’t.”

How much cash? 5-10%

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