Keeping most of your wealth in cash is very appealing. Everyone is familiar with cash and it allows you to keep track of your wealth easily. Looking at your bank account and seeing one number can be reassuring. But for those that have built up a considerable amount of wealth, it’s important to understand the downsides. Cash may be king, but its reign can only go so far.
The main enemy of cash is inflation. Interest on your money can offset some of the loss, but price rises for goods and services can erode the value of your cash considerably. The inflationary environment currently affecting most western economies means as time ticks by, your money will not stretch as far. The number next to your account might stay the same, but the funds are in fact worth less.
A further downside of cash is that it can generate less of a return than some other assets. The interest rate you receive may be acceptable, but it could be lower than the return you would receive elsewhere. It is also important to be aware of the impact of international currency fluctuations. Currencies rise and fall in value in relation to each other. Sterling may be worth $1.50 this year, but fall to $1.25 next year. Those with large holdings of cash may feel like they are maintaining their wealth, but if that currency is weakening in relation to others, your relative wealth is diminishing.
Strength in diversity
Avoiding the cash trap is best achieved by focusing on diversification. Holding some cash, particularly in various currencies, is a good idea. It is flexible and ensures you will have enough liquidity to meet your living costs. But exploring how to deploy your wealth in the best way possible and understanding the investment options available to you is something everyone should do.
Stocks and bonds are the staples of a healthy investment portfolio. Stocks give you part ownership of a company and will rise and fall in value in line with a company’s fortunes. They can pay a regular dividend, which is a share of the company’s profits, but sometimes a dividend may be withheld if profits are weak. Bonds are a form of debt and are known as a fixed income product because, unlike shares, they pay a guaranteed coupon until they mature. Whereas shares are a permanent asset, most bonds have a limited life and the original amount they sold for will be paid back to the holder on maturity.
Stocks and bonds can be bought individually or in groups. An index, for example, is a group of securities that have some kind of common association. For example, the FTSE 100 index is a basket of shares made up of the largest companies on the London Stock Exchange. If you would like to invest in technology companies in China or telecoms companies in the United States, indexes can be found to facilitate that. There are also many varieties of funds that are available to invest in which typically allow you to pool your money with other investors. Wealth can be placed with hedge funds that employ a group of expert managers to invest on your behalf or placed with a private equity fund that buys and sells companies in the hope of increasing their value. Listed products like investment trusts are also common and worth exploring.
A wider world of investing
Beyond stocks and bonds, there are variety of other assets that someone can invest their wealth in over keeping it in cash. The commodities space offers a variety of ways to gain exposure to natural resources while instruments such as derivatives can be useful for both investing and hedging. While it is wise to be aware of the potential downsides of too much cash, having a diversified portfolio of currency can ensure your risk is spread. Property is a more familiar investment to most people and can form an important part of any wealth management strategy.
An experienced wealth manager is well-placed to advise you on making better use of your excess cash. Sitting down with an adviser will allow you to work out your priorities and decide the level of risk you are comfortable with. A wealth manager can also help you with important processes like cashflow modelling which allows you to examine your assets and debt along with income and expenditure. Projections can then be created on your future finances.
At London & Capital, we want to make sure that your wealth is deployed in a way that is the most beneficial for your circumstances. Understanding cash and how much of it you should hold is fundamental to making sure your wealth is working as hard as possible.
