New research suggests that one in three people may be holding too much cash in the midst of rising inflation. Are you making the mistake of holding more cash than you need? And what else does the research reveal? Let’s take a look.
[top_pitch]
Rising inflation: what is the biggest mistake people make with their cash?
According to new research by Hargreaves Lansdown, one in three people may be holding ‘too much’ cash.
This is a mistake, according to Sarah Coles, senior personal finance analyst at Hargreaves Lansdown. She explains: “There’s a hidden inflation threat looming over one in three people: they’re hoarding too much cash and watching the spending power of their money drop with every passing day. One in three people have more than the maximum recommended emergency fund, and one in seven people are sitting on a cash pile without having invested a penny.”
Right now, inflation is running at 5.4%, according to the ONS. As no savings accounts currently pay anything close to this (the highest easy-access savings rate pays just 0.71%), anyone who has cash in a savings account is essentially witnessing their wealth decrease over time.
Because of rising inflation, it’s recommended that you shouldn’t hold more than three to six months’ worth of ‘essential expenses’ in cash. Despite this, 14% of those surveyed have more than this amount with no investments to speak of.
Cash hoarding among homeowners
Hargreaves Lansdown’s data also reveals that sitting on piles of cash is more common among homeowners.
For those with a mortgage, 15% reportedly have more than six months’ worth of cash and no investments. Meanwhile, 73% of those who own their home outright have more than the recommended amount of cash. Added to that, 23% of this group have more than the recommended amount saved and don’t invest.
Renters, on the other hand, are much less likely to be holding too much cash. That’s because the data also reveals that just 9% of non-homeowners have more than three to six worth of expenses in cash.
However, this is probably because of the fact that renters are typically less well off than homeowners. As a result, many renters are unlikely to be holding less than six months worth of emergency savings out of choice.
[middle_pitch]
Why should you hold three to six months of savings in cash?
Sarah Coles suggests that having three to six months’ worth of essential expenses available to access in an emergency is sensible for most. She explains: “As a rule of thumb, to be financially resilient, while you’re working, you should have three to six months’ worth of essential expenses in an easy access savings account for emergencies.”
However, Coles explains how having more than this isn’t always a bad idea, so long as you have a need for the cash in the medium term.
“Not everyone with more than six months’ worth of cash is taking a needless inflation risk, because you should also have cash available for major planned expenses due over the next five years. So if you’re saving up for a house purchase or move, for example, you may be sitting on more cash than this for a period. However, there’s every sign that a huge number of cash hoarders aren’t holding it for a specific reason.”
Coles goes on to highlight how many workers are simply saving on the basis that “the more they have in emergency savings, the better”. She adds that many eager savers are probably reluctant to invest due to the perceived level of risk.
However, Coles points out that many of these savers are probably “overlooking” the risks involved with keeping cash – particularly the risk of their cash being eroded by inflation.
How can you protect your cash from inflation?
Returns from putting your wealth in an investing account traditionally outperform those from savings. This is particularly true for those investing with a long-term investing horizon in mind.
Despite this, investing is totally different from saving as your capital is at risk. It should also be taken into account that past performance should never be used as an indicator of future returns.
So, while many suggest it is better to invest than save in order to protect your wealth from inflation, there’s no guarantee that returns from investing will beat inflation. Plus, stocks and shares can be directly impacted by inflation, just like savings rates. For more on this, see our article on how inflation can impact investments.
If you’re reluctant to invest in the current high inflation environment, then you may wish to explore investing in assets such as fine art, antiques or commodities. For other tips, see our article offering four top tips to protect your money from inflation in 2022.
Are you new to investing? To learn more, take a look at The Motley Fool’s investing basics.
