Why cash is no longer king: The risk of not taking enough risk

Interest rates have been low since the 2008 financial crisis. In March of this year, the Bank of England dropped its Base rate twice. It now stands at just 0.1%.

Switzerland, Denmark, and Japan all have negative interest rates, and the Bank of England hasn’t ruled out a drop to negative rates here. All of this is bad news for savers.

Cash was once king but is that still the case? Could the biggest risk be not taking enough risk? And if so, does that mean now is the time to turn to investments?

There are some benefits to savings, but cash is no longer king

We’d always recommend you have an emergency fund in place, ideally of around three months’ earnings. This is to tide you over if the unexpected happens and an accident, illness, or redundancy leaves you without income.

Keeping this emergency fund in cash means that you have quick access to it if you need it.

You also have the added security of knowing that your savings are protected. The Financial Services Compensation Scheme (FSCS) protects your savings up to the value of £85,000 per person (or £170,000 for joint accounts), should your bank or building society fail.

With interest rates low, you won’t be seeing much in the way of returns, but neither are you risking losing your money. Unless, of course, you factor in inflation.

Investing could prevent your money from losing value in real terms

The Office for National Statistics confirms that the average rate of inflation in 2018 was 2.8%. Any savings you held with an interest rate below that amount were not keeping up with the cost of living. Your savings were therefore effectively losing value in real terms.

Investing might enable you to see returns that keep up with – or even outstrip – inflation. It comes with added risk but with rates low (not to mention the threat of negative rates in the future) the biggest risk might be not taking any risk at all.

Three main factors influence your attitude to risk

If you decide you would like to invest some of your cash savings, you’ll need to balance your attitude to risk with your ideal investment outcome. The key is to take the minimum amount of risk you can, while still achieving your goal.

Three main factors influence the level of investment risk you are willing to take, and therefore the potential returns you might see.

  • Your capacity for loss – Before you start investing, you need to understand how much you can afford to lose. This will determine the amount you invest, and the risk you are willing to take with that investment.
  • Your investment goals – If you’re in your thirties or forties and investing for your own retirement, you have a long investment period and can probably afford to take a greater risk. If you’re investing on behalf of a child and intend to use the money for their education, not only might you have shorter timescales, but you might also be less inclined to take a risk.
  • The timescale of your investment – you should always look to invest for at least five years, but the longer the better. General market trends are upward ones. A lengthy timescale allows for the best chance of growth and allows time for recovery after periods of short-term volatility.

Asset allocation and diversification can help to spread risk 

You can choose to invest in several different asset classes, each with their own level of risk. There are four main asset classes:

  • Bonds
  • Cash
  • Stocks and shares
  • Property

Government bonds (or ‘gilts’) will carry a low level of risk, while property and some equities will carry greater risk. Splitting your investments between these will spread the risk. This is known as diversification and you can make use of it elsewhere in your portfolio too.

As well as spreading your investment across asset classes, you’ll want to further diversify by selecting investments across different industries and in different parts of the world. By spreading your investments, you spread the risk too.

A fall in one geographical area or one sector could be offset by a rise in another.

A small amount of risk might be necessary to keep pace with inflation

Interest rates are currently at a historic low and with negative rates already in effect in some parts of the world, it cannot be ruled out here in the UK.

Although there are benefits to cash savings for an emergency fund, low-interest rates, and the impact of inflation mean that your money is effectively losing value in real terms.

Taking a small amount of investment risk might be needed to keep pace with the cost of living. If you can afford to take slightly more risk – dependent on your investment goals, capacity for loss, and investment length – you might even outstrip inflation.

Get in touch

If you’d like to discuss any aspect of your investments, or your long-term financial plan, get in touch. Please email enquiries@hda-ifa.co.uk or call 01242 514563.

Please note

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

 

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