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How much of my savings should I have in cash? It’s a question we all ask ourselves when managing our finances. Finding an appropriate answer depends on what we ultimately want the cash for.

One thing is clear: everyone needs some emergency cash. No one knows what challenges may lie around the next corner – there are just too many potential known-unknowns and unknown-unknowns, from a leaky roof that needs fixing to an unexpected drop in income.  

In fact, we don’t think you should be investing at all if you don’t first have a rainy-day cash fund that covers at least three months of your outgoings – and with the cost of goods and services going up, that’s probably more money than it used to be!

We do not want you to be forced to sell your investments in order to fund an emergency, when the market may be down.

Our view is that your contingency cash budget should always be tied to your personal financial circumstances – and, if need be, to those of your partner and/or family too. It’s something I looked at in more detail in an article last year.

Too much cash?

But is it possible to have too much cash?

Potentially, yes. Because over and above any rainy-day funding, your cash holdings could be detrimental to your long-term investment interests by dragging on the performance of your overall portfolio.

I’ve previously discussed how investing in a globally diversified portfolio can help earn you a superior return than cash in the long run – and an inflation-beating one to boot. It might mean that the value of holdings bumps around more in the short run as markets rise and fall, which means the risk of a capital loss can never be discounted, but it’s why you invest in the first place – to grow your wealth.

Which is why it’s generally better to be fully invested in your individual savings account (ISA), general account or self-invested personal pension (SIPP), since having too high a cash holding can hold you back in your wealth quest.

To illustrate that, consider the chart below. It shows what would happen to a £100,000 pot that was fully invested in an all-share portfolio earning a 5.5% average annual return after costs and what would happen to comparable portfolios that each year were instead only three-quarters-invested in shares, with the rest in cash earning either 1% interest or 3% interest.

Over time, the cash penalty is quite startling – so much so that after 20 years, it amounts in one of these examples to well over £50,000.    

Mind the gap: How cash can hold back the value of your portfolio over time

Source: Vanguard. Note: For illustrative purposes only. Assumes a hypothetical 5.5% return for shares after costs.

Cash in an investment portfolio can sometimes indicate that an investor is keeping their powder dry – that is, biding their time before investing this money because they believe they can get in at a better price.

It may also reflect a desire by an investor to spread their investments out – again to get a better price.

However, it’s time in the market not market timing that matters most in the long run because it’s very difficult to time the market (and potential very damaging to your wealth of you sell into a downturn, unnecessarily realising losses and missing out when markets recover.

Take the chart below, which shows how the best and worst trading days often happen close together. It’s why we regard patience and discipline as investment virtues.

Why timing the market is futile

Past performance is not a reliable indicator of future results.

Notes: The chart shows daily returns of the MSCI World Price Index from 1 January 1980 to 31 December 1987 and the MSCI AC World Price Index thereafter. The yellow bars highlight the 20 best trading days since 1 January 1980 and the tale bars highlight the 20 worst trading days since 1 January 1980.

Source: Vanguard calculations in GBP, based on data from Refinitiv, as at 22 March 2023.

So remember the order: cash savings for emergencies first, investments that seek a superior long-term return second. You won’t get the kind of long-term returns with a rainy-day cash buffer that investing your money can potentially get you, but at least you’ll have peace of mind knowing you have something quick to lean on through the bad times.

Investment risk information

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

Important information

This article is designed for use by, and is directed only at, persons resident in the UK.

The information contained in this article is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so.  The information in this article does not constitute legal, tax, or investment advice. You must not, therefore, rely on the content of this document when making any investment decisions.

Issued by Vanguard Asset Management Limited, which is authorised and regulated in the UK by the Financial Conduct Authority.

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