Important information: The value of investments and the income from them can go down as well as up, so you may get back less than you invest.
Returns for those holding money in cash savings accounts took another tumble last week when the state-backed savings provider took an axe to rates.
National Savings & Investments - known as NS&I - cut rates on popular accounts to almost zero, including its Direct Saver account, which fell from 1% to 0.15%, and on its one-year Income Bond, which dropped from 1.15% to just 0.01%. The chances of winning prizes from Premium Bonds - which are also managed by NS&I - were also reduced.
The cuts affect savers in these accounts, of course, but are also likely to push rates for other providers down as well. The NS&I accounts were market-leading, meaning other providers no longer have to match them to attract savers’ cash.
NS&I made the changes because it has seen an influx of cash since the pandemic struck. The fact that many households have seen their spending fall, and because many see the sense in saving now to shore up their financial security, means many savers have more cash to stash away. NS&I has a quota for the money it can accept each year, set by the Government, and will make rates unattractive when the limit has been reached.
It further reduces the attraction of cash savings, which have been low for some time. Unlike money invested in assets like shares or bonds, cash returns are risk free (barring the risk of inflation, of course) and even those willing to take the risk on investments are likely to also have part of their wealth held in cash.
Getting the right balance between cash and investments is important. If you hold more in cash than you really need, then the growth potential of your overall savings pot will be lower and you may struggle to hit your long-term financial goals. That said, holding money in cash is important to ensure you have funds on hand when you need them - and cash will actually help you invest successfully because it allows you to leave investments untouched for longer periods.
Here are a few things to consider when setting your mix of cash and investments.
Rainy day cash means you can forget market storms
Some cash savings should be built before investments are considered. If you have rainy day money separate from your investments it means that you’re less likely to have to raid investments if you need cash at short notice - which means you’re less likely to have to make a loss by selling investments when they have fallen in value.
How much cash should you hold before you take the plunge into investing? It can be useful to think of cash savings as being in separate pots, for separate purposes, even if they are in fact held in the same account. There could be the money you think you need for real emergencies - perhaps a sudden loss of income when you’ll need to take care of essential expenses from savings. How much you need will depend on you but think about it in terms of your monthly outgoings. Holding savings worth three months of essential costs is often advised.
Then there are savings that you may wish to dip into more readily, and then replenish afterwards. If you have holiday plans or other large expenses that don’t come along every month, but perhaps every year or so, build some savings for this too. Again, this is personal, but it could be equal to a month’s gross salary.
If you have all these potential costs covered with cash savings, you could be ready to invest.
Drip-feeding means you’ll get more if markets fall
If you stick all your cash savings into investments in one go you will create the potential for a nasty cliff-edge, should markets take a sudden fall. This is perhaps the scenario that cash savers fear the most.
By setting up a regular savings plan, with a set amount fed from cash into investments each month, you won’t be risking it all. If markets fall, that hurts the money you have invested but it means that the money you invest next month will buy more assets. You are buying low (or lower), which is a decent investing principle to follow.
When prices recover, as they tend to do in the long term, you’ll feel a bigger bounce.
The effect works in reverse when markets are rising but if you’re worried about markets falling, drip-feeding offers valuable peace of mind.
Cash on the sidelines
Experienced investors will often talk about holding cash “in reserve”, “off the table” or “on the sildelines”. For practical purposes, this may be money held within the cash facility of an investment account, investment ISA or Self-invested personal pension (SIPP).
It is there, ready to take advantage of investment opportunities. Successful investing means buying low and selling high, and having cash on the sidelines enables you to do it. If your assets fall in value, as they will from time to time, it could be a great time to buy more because you’ll get more assets for your money.
It’s not a good idea to switch wholesale in and out of cash - that amounts to attempting to time the market, which seldom works - but allowing cash reserves to build at the margin over time can leave you well-placed to take advantage of opportunities when they arise.
Important information: The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.
We are at peak profits - but markets will keep motoring
Markets move from hope to growth phase
Investing for income - why 2021 is a good year for dividends
How to invest for income in 2021