Cash is King / Queen Part II
Where did we leave off?
While I discussed the importance of cashflow in "Cash is King, Part I", this blog sets to uncover the importance of cash.
One question I'm typically asked is around how much cash you should hold in your bank account.
Invariably most blogs will tell you you need four times your salary as a cash buffer in case you loose your job, your boiler breaks or you find yourself with an out of the blue tax bill. I agree.
By the same token, most of these blogs will argue that you should hold no more than "the emergency fund"; why?
Depreciating effect of money...
As I have discussed in earlier blogs, inflation is when the cost of goods increases. The rate at which this increase happens is called the inflation rate.
The problem is; if you have money sat in your bank account, earning very little interest (like now) but inflation is increasing, then technically what your money can buy now will be less in one year from now. For example, a loaf of bread may cost £1.06 (Office of National Statistics) now, however, that same price of bread only cost £1 a year ago. £1 sat in your bank account a year ago, would have bought a loaf of bread. That same pound coin no longer buys a loaf of bread. The value of your money in your bank account has decreased. This tends to be compounded by wages which have not increased up in line with inflation; buying goods takes a higher proportion of our salaries.
How to Counter This?
Investing offers a method to counter the decreasing effect of money; the returns associated with investing are often significantly greater than interest associated on savings, and therefore your money tracks up over time, against rising inflation.
I am a strong believe in investing and I fully appreciate the concept of inflation and the time value of money. However, while investing is core to offset the effects of inflation, I believe that we should not get too stressed and obsessed with it. Having money in my bank account, for me, as important as investing.
Options: While many people may take outrage at what I'm about to say, I'm a strong believer that money buys you options. It buys you choices, and it provides you with a buffer of time to consider your decisions. Money in your account means you are not scrabbling around trying to work out what bill you can delay paying as you weren't expecting another expense coming into your account. Coupled with this, the value of goods, tends to vary significantly over time.
Lets look at the example of bread again: the below shows the price of bread over 10 years. What's interesting to note is that the cost of bread in 2012 and 2013 was significantly higher than the cost now. During 2012 and 2013, I might have thought it best to invest my money to stop it depreciating in value. However, now in 2017, my money is locked up in investments.
Investing my money for the future is important, but as discussed in other blogs, investing should be done over the long term; I might actually need this money short term. I'm not saying "don't invest", just do not panic invest and put all your money in investments.
Having cash in your bank account now is as important (in my opinion) as investing in the long term.
Photo from the beautiful unsplash.com