Cash has traditionally been seen as a secure method to retain your money since it is readily available and there is little chance of losing it.
While keeping cash on hand or in a savings account might be secure, holding onto excessive amounts of cash could be detrimental to your long-term financial stability.
In actuality, it could benefit to diversify your holdings of money, moving away from cash and bonds and towards stocks, commodities, and real estate.
Cash is something we are all acquainted with and often utilize. Some people might not realize that having too much cash can really be detrimental. Naturally, it depends on how much cash you have in relation to your particular situation.
In addition to providing liquidity and being an asset class that performs considerably differently from those we know to be alternatives, such as bonds or equities (stocks and shares), cash may also be highly valuable in an investing portfolio.
Here are some explanations as to why holding too much cash may be a bad idea.
Percy Grunwald, co-founder of Compare Banks tells us: “The only true drawback of having a lot of cash on hand is that it prevents a company from expanding as much.
While it makes sense for a corporation to have some liquid assets on hand, the remainder of its revenue can often be put to better use by bolstering the business or funding development.
Money may be used to pay off debt, increase wages to recruit more and better employees, or invest in long-term profitable ventures rather than adding to a big cash position.
Although a cash balance is safer, unless it is used, it offers nothing to help a firm expand or a person’s individual net worth.”
Savings in cash depreciate with time
Short-term financial stability is not a problem. It’s certainly wise and necessary to have money on hand that you may use as needed for regular expenses or emergencies.
However, if the interest rate you are getting is lower than the rate of inflation, cash may start to lose value over an extended period of time.
Assume that in 2010 you deposited 1000 pounds in a savings account. Using the Bank of England’s inflation calculator, we can determine that given a 2.7% annual inflation rate, goods and services costing £1,000 in 2010 would have cost £1,311.26 in 2020.
However, throughout the same time period, the average interest yield on a savings account was around 1.7%. Therefore, the same £1,000 stored in a savings account with convenient access would only have increased to around £1,170.
This implies that the actual worth of your money would have decreased.
Your cash’s interest earnings can be taxed
If you have a sizable sum of cash in savings, the interest it earns can be taxed, particularly if you have a high salary.
You could be eligible for a Personal Savings Allowance, which means that a portion of the interest you can earn on your account is tax-free, depending on your income.
But if you keep the majority of your savings in cash, you could have to pay taxes on them.
Because interest earned on funds in a Cash ISA is tax-free, keeping your money in one may assist solve this problem.
You may not be able to shift all of your money in one tax year, though, since there is an annual limit on how much you may put into an ISA in each tax year, which is £20,000 for 2020/21.
The possibility of interest rates falling to 0% means that you may pay a bank to store your funds
Instead of earning interest on their cash held with the Bank of England, commercial banks would have to pay to do so.
As a result, banks are encouraged to lend their funds rather than keeping them in cash, with the hope that doing so would stimulate the economy.
However, you could pay these fees by receiving a negative interest rate on your savings account. Negative interest rates may require you to pay a bank for the privilege of making a deposit.
Rainy Day Funds Can Become Excessive
André Disselkamp, financial expert and founder of Insurancy shares: “If a sum of money is an “emergency fund,” it may not make sense to lock it up for longer than a year.
A cash reserve would have been particularly helpful in the past couple of years due to the number of layoffs and furloughs.
For those over 55 who were tempted to draw into their pension funds, it would have served as a helpful cushion.
Financial advisors typically advise clients to save three to six months’ worth of expenses in cash, however, some have proposed boosting that amount in light of the weakening economy.”
An enough cushion of around £12,000 is available with an average net monthly wage of £2,000 in the UK to cover mortgage payments and other household expenses.
You won’t be eligible for Universal Credit, a monthly payment to assist the unemployed with living expenses unless you have saved £16,000. Savings below £6,000 have no bearing on eligibility for Universal Credit.
Investing in asset types other than cash has often outperformed cash
You might include a variety of other asset types in your investing portfolio that would perform better than cash.
These could include, for instance, fixed-interest securities, alternative investments, real estate, or stocks.
While having a well-diversified portfolio made up of the aforementioned asset classes is a distinct topic of discussion, investing in the aforementioned alternatives to cash has the potential to provide superior returns over the long run.
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