With no travel and Covid-19 restrictions causing shops, restaurants and bars to close for large parts of last year, 2020 has seen an increase in savings for many. For some, more time spent at home has led to finally ticking off that task of consolidating old bank accounts or tracking down old investments.
For those who have been fortunate enough to save more throughout 2020, holding these savings in cash can be comforting during times of uncertainty and a safe option when the economy is volatile. But there are risks associated with holding too much of your wealth in cash.
Inflation: Impacting the value of savings
We are currently in a period of low-interest rates with banks slashing savings rates. While low interest rates can be good news for those of us paying down loans, low rates are not so positive for people holding excess cash.
This is because each year the cost of living increases and if interest rates fail to keep pace with this, then your savings will gradually be able to purchase less and less.
For example, say you have $10,000 in an account that pays a 1% interest rate. After a year, you will have $10,100 in your account. But if the rate of inflation is 2%, you would need $10,200 to have the same purchasing power that you started with.
How can we protect our savings from the effects of inflation?
Assuming we have 3 – 6 months’ worth of livings expenses in cash to act as emergency reserves and we have paid down any bad debts, then investing this excess cash can be one way to beat the impact of inflation on your cash holdings.
Investing the excess cash you have saved can be done in 2 ways:
- Lump Sum – starting a new portfolio, or contributing to an existing one, investing a lump sum in a portfolio aligned to your risk profile and investment time horizon will allow your excess cash to gain exposure to the markets straight away.
- Slow and steady approach – whether increasing your current regular savings plan or commencing a new plan, this approach allows you to utilise the benefits of dollar cost averaging. This approach involves making investments at regular intervals over a period of time which assists in mitigating the risks of volatility and timing the market.
If you are one of the fortunate ones that has found themselves with increased savings over 2020, it is important to remember the risks of holding these funds in cash over the long term. Although cash can be comforting to hold, it is important to consider that investing your excess savings can help protect against the effects of inflation and assist you in meeting your long-term financial goals. A dependable financial advisor can give you valuable insights to help you chose which options best suit you.
When considering any strategy, it’s important to appreciate what might be appropriate for your personal situation before taking any action steps. Contact us today to find out more.