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Why cash isn’t always king – exploring other cash-type investments
Amid heightened geopolitical and market uncertainty, and encouraged by interest rates that are still relatively high, some of your clients may be tempted to move their investments into cash or savings accounts.
But before they do, it’s important they understand the implications of this on their long-term financial plans and consider whether cash-type investments could better meet their needs. Let’s take a closer look.
The comfort of cash
Although some central banks have started cutting rates, interest rates on cash and savings accounts remain attractive and some investors may have been enticed out of equities and other higher-risk assets and into cash. The possibility of economic uncertainty ahead may also have prompted them to seek the perceived safety of cash.
Cash clearly provides the predictability and greater certainty that more cautious investors want. It’s a low-risk asset that doesn’t experience the same ups and downs as investments such as equities and property, whose prices can fluctuate, sometimes dramatically. You know the interest rates on savings upfront and avoid the downside.
Liquidity is another important factor for wanting to move into cash, especially given the current cost-of-living constraints. It means you can access money quickly to cover short-term needs, emergency purchases or unexpected bills.
Cash cons
While these are all understandable motives for wanting to move money out of investments and into cash, there are potential drawbacks:
- Although interest rates remain higher than they have been for many years, cash generally offers very low returns over the long term compared to investments such as equities or property.
- There’s an ‘opportunity cost’ with allocating a significant portion of a portfolio to cash. By disinvesting, you may miss out on any market rallies and opportunities for growth. In addition, you sacrifice the opportunity to benefit from any dividend or income payments you could have earned if you’d stayed invested. With such limited growth potential, holding cash for prolonged periods could hinder your clients in achieving their long-term financial goals.
- Although interest rates are currently higher than inflation, over the long term, cash is vulnerable to inflation risk, meaning cash savings are likely to lose value in real terms when held over long periods of time.
- Finally, timing the market, by hopping in and out of riskier investments and into cash when turbulence seems to be looming, is extremely difficult and rarely successful over the long term. It’s also worth remembering that volatility can create opportunity and exiting the market at the wrong time may lock in losses.
What are the alternatives to cash savings?
If you have clients who are looking to make a return but with greater security and/or liquidity, there are alternatives to simply moving their money into a cash or savings account. Money market funds, for example, are designed to offer investors a high level of stability and liquidity, while also generating a modest investment return above cash and savings account interest rates.
They usually include a mix of certificates of deposit, commercial paper, floating-rate notes and short-term assets, which are generally highly liquid, meaning they can be suitable for short-term investment. This liquidity also means that money market fund managers can move quickly to take advantage of market opportunities. And the broad mix of assets across a wide range of issuers minimises credit risk – where an issuer is unable to make income or capital payments or their credit rating is downgraded.
In terms of returns, money market funds offer a yield rather than an interest rate. The yields on these funds can often be higher than the interest rate paid on a platform cash account, even after charges are deducted. So your clients could benefit from higher but still relatively stable returns.
Of course, unlike cash and savings accounts, which have set interest rates, the value of money invested in money market funds can go down as well as up and isn’t guaranteed. And as they’re lower risk, they offer lower long-term return potential than other investments such as equities, property and longer-term bonds. It’s also important to remember that charges apply to money market funds. In some scenarios, when returns are low, charges can result in negative returns.
Lastly, bear in mind that from 1 June 2024, the FCA has required pension providers to issue cash warnings to customers who have significant and sustained cash holdings in their non-workplace pension until up to five years before the normal minimum pension age. This includes cash-like assets as well as cash savings. So you should consider whether long-term holdings in money market funds are appropriate, particularly for accumulation clients.
When you might want to consider a money market fund for your clients
When a client might want an investment that’s:
- liquid enough to suit their short-term goals for some or all of their money
- a temporary place for their money while looking for other investment options
- a platform cash account substitute offering the potential for slightly higher but still relatively stable returns
- a lower risk investment to diversify part of their portfolio – for example to balance out the fluctuations of higher risk investments like equities.
To find out more about the money market funds we offer your clients, speak to your usual Royal London contact. Our range includes deposit, short-term fixed income and absolute return government bond strategies.
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