Often when I speak to people about investing, they see it as a middle-aged pursuit of reading the share prices in the paper and talking endlessly about portfolios. Based on this perception, it is easy to see how this can be seen as a dull pursuit that can be dealt with at some point in later life. However, I recently also spoke to a colleague who was 'saving' any spare cash he had, not for a specific reason but because he did not know what to do with it. He had £50K in cash, increasing by £1000 per month.
This is not to say that all cash is bad. There is a 'cash is trash' army out there that will try and convince you otherwise. But it is always good to have an emergency fund in case of emergencies. Pre-pandemic standard thinking was 3-6 months (depending on employment status) to cover essential household spending if you could not work. Post pandemic, some experts suggest you should have up to 12 months of available cash.
So after you have the cover for unforeseen circumstances, isn't investing, stock markets and other investments all a bit risky? Any action has its benefits and potential risks, and the key risk to keeping everything in cash is inflation. Keeping money in cash is relatively safe up to a certain amount and easily accessible if you need it, but you need to understand what inflation is doing to your cash savings.
Let's look at an example:
If you have £1000 in savings and do not add anything to it. If your bank is offering you a 0.4% return and inflation is at 5.4% (the current stated level of CPI in the UK), your money is eroding by 5% per year and will be worth 95% of today's value in 12 months.
So what does this look like over time? If you do nothing over the next 20 years and your return and inflation stay the same, this is what your £1000 (in today's money) will look like:
1 year = £951.13
3 years = £860.44
5 years = £778.38
10 years = £605.90
15 years = £471.63
20 years = £367.11
The only way to make sure this does not happen is to invest in assets greater than the rate of inflation. More on what to potentially invest in future posts and how we calculate inflation, but for now, it is important to understand why people say cash is trash and the importance of investing.
- Do you have an emergency fund? If you need to stop working today, how many months would you be able to pay basic expenses? 1,3,6,12 months or less? Do you need to save more or less in this fund?
- Do you have any savings in addition to this doing nothing or having very low rates of return? Could they be put to better use?