Cash can play a critical role in realising your financial and life goals – but it needs to be seen as part of a broader wealth plan.
Whenever there is financial, economic or political uncertainty, investors can often consider whether they should move some of their assets into classes traditionally seen as “safer” – the primary one being cash.
While such thinking may be understandable when the financial picture is turbulent, it’s always best to avoid emotionally charged decisions when managing money and investments.
When it comes to cash, in particular, there isn’t one single answer to the question, “How much should I hold?” As with any wealth-planning decision, the key is to take a step back and look at the bigger picture: the balance between the assets you hold and how this aligns with your short-, mid- and long-term goals, your age, tolerance to risk and existing investment portfolio choices will all come into play.
At the simplest level, cash holdings typically include savings accounts and deposit accounts such as fixed-term deposits, and premium bonds.
“When thinking about cash, it’s important to consider liquidity,” explains Chris Wilson, director – Investment Counsellors at RBC Wealth Management in the British Isles. “Cash assets are something you would usually want to be able to access pretty quickly for whatever reason. However, not all cash holdings can be accessed instantly, or they may come with a penalty for doing so.”
It’s also important to note that while liquid assets usually come with lower risk and lower returns, that doesn’t mean there is zero risk. “For example, a bond market can be very liquid, but you could be forced to sell a bond at a time when the market is down,” says Wilson. “So, we would deem that as riskier than something like a savings account or a fixed-term deposit.”
Perhaps the most important question to start with is not “How much cash should I hold?” but “What are my financial goals?” Once you have worked out what those objectives are, you can better determine what to do with your assets, including cash, and what your risk profile is.
Individuals could consider segregating their wealth planning into multiple investment objectives, such as retirement planning, paying for children’s (or grandchildren’s) school or university fees, investing in a business, buying or renovating a home and providing for family after death.
These goals will likely require different investment approaches. In some instances, it makes sense to tie funds up for the long term, whereas others may need more liquidity.
“When it comes to working out how much cash to hold, a useful starting point is to break it down into planned and unplanned expenses,” says Nick Ritchie, senior director of Wealth Planning at RBC Wealth Management in the British Isles. “Planned expenses could include the basic costs of running a home and going on holiday. These expenditures could be paid for by a regular income, for those who are still earning, or come out of cash reserves, for those who aren’t.”
He adds: “Then there are planned larger capital expenses, such as home renovations or a new car, which could happen in the next few years and can’t be paid for from income alone. If this is in a three-to-five-year time horizon, it may be worth retaining that in cash and keeping it relatively accessible.”
More unpredictable, of course, are the unplanned expenses, such as unexpected tax bills, home repairs or a change in professional circumstances – and it’s here that investors will need to look at cash-flow management to establish their “rainy day” fund. “This is personal to the individual,” says Ritchie. “But we might say to retain six-to-12 months’ worth of expenditure, so that if someone doesn’t want to be forced to access their investments, they’ve got readily available capital.”
The amount of ready capital will vary from one person to another. For private equity professionals, for instance, who may receive capital calls, the fund would likely be much larger. “By anticipating liquidity demands, the more likely someone will be able to avoid becoming a forced seller of investments,” explains Ritchie. “Not least because this can potentially crystallise a loss.”
“When times are uncertain, investors may want to hold on to cash until markets pick up or there is less volatility,” says Wilson. “But the problem with trying to ‘time’ the market like this is they could miss the boat. Higher interest rates can complicate the picture slightly, in that some investors may feel it is sensible to keep cash destined for inevitable investments in savings, rather than long-term assets such as equities. But as history continues to show, the markets typically outperform cash in the longer term .”
Ultimately, deciding how much cash to hold depends on what you need it for. The following factors can help with your decision-making:
Other considerations when thinking about cash are external factors such as inflation and any tax implications. In a high-inflation environment, for example, are any gains from interest being eroded, and does this need addressing?
Regarding tax, if an individual is a higher-rate taxpayer, then any interest received may well be liable for tax at 45 percent. So, it’s important to consider mitigating this by using the annual cash ISA allowance of £20,000 or products such as premium bonds, in which returns are tax-free.
Cash is just one asset you can use as part of a diversified approach to investing. A 2023 RBC Wealth Management survey of 600 British high-net-worth individuals (HNWIs) showed that 72 percent need some form of guidance on investment management, and 86 percent of 25-to-54-year-old high-net-worth individuals need direction on how to diversify the ways in which their assets are held.
Be it during turbulent times, after a liquidity event, or when the markets are more stable, the need for ongoing wealth-planning advice can’t be understated if you are to achieve your financial goals, whatever the time frames may be.
This publication has been issued by Royal Bank of Canada on behalf of certain RBC ® companies that form part of the international network of RBC Wealth Management. You should carefully read any risk warnings or regulatory disclosures in this publication or in any other literature accompanying this publication or transmitted to you by Royal Bank of Canada, its affiliates or subsidiaries.
The information contained in this report has been compiled by Royal Bank of Canada and/or its affiliates from sources believed to be reliable, but no representation or warranty, express or implied is made to its accuracy, completeness or correctness. All opinions and estimates contained in this report are judgments as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. This report is not an offer to sell or a solicitation of an offer to buy any securities. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Every province in Canada, state in the U.S. and most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as the process for doing so. As a result, any securities discussed in this report may not be eligible for sale in some jurisdictions. This report is not, and under no circumstances should be construed as, a solicitation to act as a securities broker or dealer in any jurisdiction by any person or company that is not legally permitted to carry on the business of a securities broker or dealer in that jurisdiction. Nothing in this report constitutes legal, accounting or tax advice or individually tailored investment advice.
This material is prepared for general circulation to clients, including clients who are affiliates of Royal Bank of Canada, and does not have regard to the particular circumstances or needs of any specific person who may read it. The investments or services contained in this report may not be suitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about the suitability of such investments or services. To the full extent permitted by law neither Royal Bank of Canada nor any of its affiliates, nor any other person, accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. No matter contained in this document may be reproduced or copied by any means without the prior consent of Royal Bank of Canada.
Clients of United Kingdom companies may be entitled to compensation from the UK Financial Services Compensation Scheme if any of these entities cannot meet its obligations. This depends on the type of business and the circumstances of the claim. Most types of investment business are covered for up to a total of £85,000. The Channel Island subsidiaries are not covered by the UK Financial Services Compensation Scheme; the offices of Royal Bank of Canada (Channel Islands) Limited in Guernsey and Jersey are covered by the respective compensation schemes in these jurisdictions for deposit taking business only.
We want to talk about your financial future.