Cash might be king, but because of the way inflation erodes cash, it makes a really bad choice of home for anything other than the very short-term.
Price inflation might have fallen recently, to below the government target of 2%, but inflation erodes cash in most cases.
With the top paying instant access savings account paying interest at 1.5%, a higher rate taxpayer is currently losing capital in real terms at a rate of around 1% a year.
Since March 2009, when the Bank Rate fell to 0.5%, a saver with £1,000 in cash has seen the real value of their capital fall to £870. This is based on a Retail Prices Index (RPI) rise of 20% over the past five years.
Inflation, time and low interest rates means inflation erodes cash to a large extent.
With the economy recovering, we might expect a period of moderate to high inflation. Interest rates are expected to rise over the next few years, but it is unlikely that net interest on cash savings will keep pace with price inflation over time.
For investors, the fact that inflation erodes cash means that it is important to hold only what is necessary in cash and consider investing any surplus.
Cash makes for a good short-term home for wealth, but for the longer-term it is asset backed investments which stand the best chance of beating inflation and preserving real value.
The latest M&G YouGov Inflation Expectations Survey has found consumers’ inflation expectations have generally fallen in the first months of 2014.
Overall, inflation expectations were recorded at their lowest level since the survey began in February 2013, possibly driven by the recent sharp declines in UK and European inflation.
Nevertheless, in the long run (five years ahead), inflation expectations remain above central bank targets in all regions, a sign that consumers still lack confidence in their central banks’ ability to achieve long-term price stability.
These inflation expectations suggest cash will remain the wrong choice for most investors.
Finding the right balance between cash and risk-assets is always tricky, but with Financial Planning it is possible to determine what needs to be held in cash and what you can afford to expose to investment risk.
