The value of your investments and the income from them may go down as well as up, and you could get back less than you invested.

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The cash conundrum – how much is the right amount?

4 min read
12 Nov 2020

If COVID-19 should teach investors anything, it is that things can come out of the blue and cause the value of your investment portfolio to fall significantly with absolutely no prior warning. No history lesson could have helped us predict what we have seen during 2020.

However, history does help us predict what will happen next. Which is that, given long enough, people will get back to work, businesses will start making profit again, life will return to normal and investment portfolios will recover.

Only two prices matter…

When it comes to investing, only two prices matter – the price at which you buy an investment and the price that you sell it. The rest is just noise, often gut wrenching, terrifying or joyful, but noise all the same. That is, however, unless you are forced to sell an investment at an inopportune time, perhaps because you need the income or you have a planned expenditure to make – like a house or car purchase.

So, counter-intuitively, the first question I ask my clients when they come to me looking for advice on how to invest, is actually ‘’how much are you going to keep back in cash and not invest?”.

How much to keep in cash?

The answer is unique to each client and depends on all kinds of things; income, job security, tolerance for risk, potential windfalls or inheritance. However, usually it is at least 1-2 years of net expenditure and could be a much as 5 years in certain circumstances. Plus, I always advise to keep a little extra just for emergencies – the proverbial roof burning down (although this did actually happen to one of my clients).

The reason I do this is it gives the value of investments time to ride out any short-term dips, to get onto a positive long-term trajectory and it decreases the chances that the client will be forced to withdraw from the portfolio when it is down.

I then work with the client to create a plan where, for the first few years they rely on cash balances; once these are depleted the portfolio should be in good enough shape for them to begin drawing down on it. We’ll review this plan regularly and if anything changes, significant short-term positive market performance for example, then we might choose to adjust it, in this case by drawing on the portfolio early or topping up their cash balance.

What if you need to spend money in 3-5 years?

Don’t invest it. You may question the wisdom of this, especially with bank savings rates at near zero, but investment portfolios can do unexpected things over short periods of time (I’ll refer you back to the year 2020 if you’re unsure). When you have money earmarked for something important like a house purchase, the last thing you want is to come to drawdown on the portfolio on the day of completion, find the portfolio is down significantly and now your new house has, in effect, got more expensive.

The best home for money earmarked for a known expenditure in the short term, is something with a known outcome. This is cash.

How do I know what the right approach for me is?

It’s not easy. The first thing to do is sit down and look at how much you spend each month or year, and also think if there’s anything you want to spend a significant amount of money on in the near future: Will that old kitchen get any less shabby? Is your son’s new girlfriend really ‘the one’?

Write it all down and then come and talk to a professional adviser. They will work with you, looking at every aspect of your financial circumstances and future goals, to create a plan for the future.

That plan should be unique to you, with a blend of cash and investments, so that it is robust enough to deal with even the most unexpected of market conditions. Most importantly, it should make you feel comfortable and confident that you are set up financially for whatever life may throw at you.

If you’d like to speak to someone about what to do with that cash lump sum, the expenditure you may have or any other questions about investing your wealth, give us a call on 020 3823 8678 to find out how we can help you.

Please consult a financial adviser before making a decisions regarding your investment portfolio.

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