My first job was in a nursing home.
I’ll always remember one of my favourite residents Sidney constantly offering me a shilling for cleaning her room.
A lovely gesture despite the denomination being out of use for 34 years by then, and the fact I was already being paid.
I think that made it all the more touching.
That was my first real brush with inflation. In her logic, that 12p equivalent was a just reward for a vacuumed carpet and new bed clothes - because in her day, it probably was.
We’ll be doing something similar in our old age I’d imagine. If you’re sure you won’t, have a guess what a Freddo costs these days. Now look here.
The difficulty is that, while we go about our daily business, the value of what the cash in our pockets can actually buy in the shops is eroding.
Investing, with the goal of at least keeping up with the rate of inflation and price rises, seems a reasonable way to try to offset that effect.
But what does that mean for any cash we hold in our investment accounts? Does it serve a purpose or is it just losing value in there too?
Here are a few thoughts on how best to incorporate cash into your investment journey, as well as how Freetrade is doing something a little different to help.
Check your balance
Like the unicyclist at the cash machine, make sure you have the right balance. (I won’t apologise for that one.)
But that balance doesn’t mean holding equal amounts of everything.
Cash really shouldn’t be one of your largest portfolio holdings, unless you’ve just sold something and are looking for somewhere else to invest it.
(Remember, we’re talking about everything in those ISA, SIPP and GIA accounts here - it’s actually a great idea to have a stash of emergency cash on hand outside of your investments in case the boiler goes or the car breaks down.)
Cash can be a real drag
If you hold more cash than you need, not only will the growth potential of your overall portfolio be lower, but that looming inflation risk is more likely to take hold.
Both of these mean your long-term financial goals look more vulnerable.
With the Bank of England’s interest rate setting records for new lows, cash sitting idle is a hindrance to you.
'Cash drag' is what the industry calls it. Like a lazy player holding the rest of the team back, it can get very frustrating watching the performance of your other assets suffer overall because of that one element standing still.
The flipside of this, of course, is that you know where you are with cash in the short term.
Other assets can introduce a higher chance of your overall portfolio value fluctuating, and that puts the relative stability of cash in the pro column.
But that begs the question - how much cash do you need?
Well, an initial answer is that you need enough outside your portfolio so you never have to dip into it.
Compounding relies on that untouched money snowballing over time so leaving it to work its magic is incredibly important.
Inside your portfolio, many people choose to keep different amounts of cash on-hand to take advantage of market blips.
5%, 10%, 15% - whatever the fraction, the danger is that you spend so long waiting to pounce that suddenly you miss your opportunity and that cash has sat there for nothing.
If that’s the strategy you’re thinking of employing, do yourself a favour and spend your time in the market, not timing the market.
I’ve said before that history is very clear on the matter - those who let their money snowball over time outperform the snipers hoping for a market dip.
Only spectators sit on the side lines
You might hear professional or experienced investors talk about taking ‘risk off the table’ by moving to cash.
And while this can be a decent course of action if you think the market is looking toppy or your investment story has played out - it’s not meant to be forever.
Investors, especially those with a value contrarian tilt, can often find their thesis has run its course and it’s time to sell.
Or, it could be that bad news means your best course of action is to cut and run.
In both cases, moving to cash should be a layover, a pitstop, a halfway house.
The longer it sits there, the longer it’s undoing all the hard work you put into achieving that growth.
Change the question
This is where the question should change from ‘how much cash?’ to ‘what is my cash doing?’
That’s because, from what we’ve seen above, putting your money to work is so important as it’s not doing anything itself, especially when investors are being starved of income from interest rates and bond yields.
There are a few negatives to that train of thought, and ones we’re trying to help with.
That urgency to deploy cash into the market can provoke hasty decisions. Like a bouncer emptying a nightclub, it becomes more about getting it out there and less about where it ends up going.
To help give investors a bit more breathing space between investments, and a chance to think clearly without worrying too much about holding cash, Freetrade Plus members will now earn 3% interest on up to £4,000 cash while they're between trades.
So if you do have cash left between trading decisions, Plus customers will still get a return.
Remember though, the bank is where you hold your cash - our investment accounts are for exactly that, investing. Make sure that’s what your main focus is if you’re using them.
You can find more about the ins and outs of our proposition here but long story short, it helps with the nagging feeling that cash is always a drawback.
Sometimes it’s necessary and when it is, we want to make sure our investors aren’t being forced to make rushed decisions when a bit more time will do.
It’s the most recent addition to your Plus account, which already has benefits like:
- Limit orders
- Stocks and shares ISA
- Priority customer support
- Access to thousands more stocks, ETFs, and trusts
It’s worth keeping in mind that your capital is at risk when you invest in the stock market - cash can be a way to alleviate that somewhat. But does it have the power to pull the rug out from under you? Absolutely.
If you are holding cash in your ISA, SIPP or general investment account (GIA), just remember you opened that account to be in the market, so don’t let that cash become a long-term holding - it’ll be the only one you’re sure to lose on.
Protect your investments from UK tax with tax-efficient investing accounts like a stocks and shares ISA or a SIPP account. Check out the ins and outs of both accounts before opening one. Take a look at what is a stocks and shares ISA and our SIPP guide. We summed up the key differences in our SIPP vs ISA guide.
This should not be read as personal investment advice and individual investors should make their own decisions or seek independent advice. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication.
When you invest, your capital is at risk. The value of your portfolio can go down as well as up and you may get back less than you invest. Past performance is not a reliable indicator of future results.
Freetrade is a trading name of Freetrade Limited, which is a member firm of the London Stock Exchange and is authorised and regulated by the Financial Conduct Authority. Registered in England and Wales (no. 09797821).