Three reasons to keep money in cash, and one big one not to

To understand why cash can be so risky for your finances over the long term, it’s important to think about why we save. This everyday practise is called ‘delayed consumption’ – in other words, putting money aside to pay for things later. When the purchasing power of cash is eroded by inflation over time, the basic tenet of saving – whether it’s for a holiday, your children’s futures, or funding your lifestyle in retirement – is undermined.

As humans, we tend to prefer things we understand, so it’s easy to buy into the straightforwardness of cash compared to investing.

However, it's important to realise that the traditional image we have of a bank with its vault stuffed with gold bullion and notes is no longer true to life. Instead, banks use a model called ‘fractional banking’, meaning they keep enough money on hand to meet day-to-day customer requirements and the rest is – you guessed it – invested.

Whilst you would assume the bank would be able to present your cash when you ask for it, there have been times when things have gone wrong, a good example being the collapse of Northern Rock around 15 years ago. It’s important to note though that each UK individual benefits from the Financial Services Compensation Scheme, protecting their money up to £85,000 per bank, building society, or credit union.

Whilst cash may not be suitable for your longer-term financial goals, holding money in cash can be useful as part of your overall financial plan. Here are three areas where cash can be a good choice:

1. For instant access

   Most of us have a day-to-day bank account to receive our salary or other income. Often, this is also used for our daily spending.

   Quilter’s investment platform works in a similar way, providing each investor with a cash account to support their regular transactions, such as making payments in and taking income out. We recommend that investors do not hold more cash than they need in this account, to ensure that as much of their money as possible can benefit from any potential investment growth.

2. As an emergency fund

   This is cash you might keep aside for a specific purpose, such as a rainy-day fund, an unexpected large expense, or a purchase in the near future.

   Depending on how quickly you’re likely to need the money, a fixed-term or notice bank account may be useful for this purpose and offer a higher rate of interest than a traditional current account.

3. To provide flexibility for your investments

   Your financial adviser may recommend you hold cash or invest in a money market fund, either to lower the risk of your overall investment portfolio, or to give you greater flexibility.

   Whilst money market funds also invest in cash, they have the benefit of being managed by a professional fund manager and can enable investors to switch into stock market investments quickly when market conditions change. Most portfolio managers and large institutions which manage money, including Quilter, use these funds when they want to invest in cash.

Speak to your financial adviser to ensure your money is working as hard as it can to meet your goals. They can recommend ways to reduce your investment risk and ensure your money isn’t being eroded by inflation.