Holding cash on deposit is a necessary part of the financial planning process. There are always unexpected twists and turns that life throws at us, so the general rule of thumb is to have two to three months’ living expenses saved in an instant access account, just in case.
However, cash is definitely not king when it comes to returns. With inflation targets of 2% per annum set by the Bank of England and base interest rates of only 0.1%, leaving large amounts of money on deposit for long periods will negatively impact your financial position over time. This additional capital sat on deposit can definitely be working harder for you.
Inflation mitigation must be considered when planning for the future. The definition of inflation is the decline of purchasing power of a given currency over time, so you quite literally get less bang for your buck the longer you hold the cash on deposit. This was illustrated in a recent Financial Times article, which estimated that a £100,000 lump sum would fall in real terms to be worth just £81,790 in only ten years.
Instead, it is worth looking towards a risk-rated equity portfolio tailored to your financial goals. Studies conducted by Barclays recently found that, since 1899, British stocks have returned 4.9% per annum in real terms – i.e. above inflation – compared to 1.3% for gilts and a mere 0.7% for cash. If we look at a shorter timescale – the last decade for instance – we saw an average growth of 5.8% for stocks, 2.7% for gilts, and a return of -2.5% per annum for cash.
Holding an equity-based for five years at any stage has a 76% chance of outperforming cash, and if you extend this period to ten years, then this figure climbs to a staggering 91%. Those statistics alone should indicate clearly that incorporating equities into your long-term planning is a must.
The key is understanding risk – an investment with short-term guarantees might actually be very high risk in the long-term if it is almost certain that the purchasing power of those funds will diminish over time. Similarly, investments with higher short-term risk might offer very low long-term risk if they keep up with inflation.
It is our role as your Wealth Strategists to help you understand investment risk and use this to develop strategies to help you achieve your financial goals. Whilst designing an investment portfolio may sound daunting, it is our job to work with you to take the guesswork out of the equation. It also helps that we are not emotionally attached to your money in the way that you are, which means that we are able to take a much more objective view of your finances.
If you, or anyone you know, think you would benefit from a conversation with one of our Wealth Strategists, then please get in touch.