What is the right amount to keep in savings?

As inflation has been higher than interest rates for some time now, savers may be asking themselves if it would be wise to invest some of their cash into a diversified investment portfolio to try to protect their money from inflation.

Inflation (measured by the consumer price index) is currently at 10.1% and the Bank of England base rate at 4% (as at February 2023), meaning the real value of cash savings is being eroded by approximately 6% a year.

And with inflation remaining elevated, holding wealth in cash may continue to erode its value in real terms.

But the question then arises of how much cash is too much to leave in the bank (and subject to the ravages of inflation) and how much to invest.

David Goodfellow, Head of UK Financial Planning at CGWM, provides some key points to think about when trying to answer that question, and gives some examples to act as a guide through this complex topic.

Key points to consider when deciding whether to invest cash

Deciding how much cash you need to keep in the bank, and how much can be invested with the aim of beating inflation, is a complicated and very personal decision. What is right for one client may be completely inappropriate for the next, so it is always best to seek advice from a professional.

But to start your thinking on the topic, we would suggest considering:

1. The security of your income. If you rely on employment income to pay your living costs, you may be well advised to keep more of a cash buffer in your account in case you lose your job. However, someone with a guaranteed income, such as a final salary pension, may be better off investing more and keeping less in the bank.
2. Your living costs. It makes sense that someone with high outgoings may wish to keep more in the bank in case of emergency than someone with lower expenses - especially with the cost of living rising rapidly.
3. Your stage in life. Someone with dependents and a mortgage may want to keep more in the bank in case of the unexpected than someone with fewer obligations.
4. Planned short-term capital expenditure. Any planned capital expenditure in the next three years (property purchases or a gift to adult children, for example) should be retained in cash.
5. Your personal comfort level. Regardless of their level of wealth, some people just feel more comfortable knowing they have a cash sum in the bank. While respecting this preference, we encourage you to consider whether keeping excess money in the bank - and hence at the mercy of inflation- is actually a higher-risk strategy than investing it in a diversified portfolio. This is because the value of cash will fall when inflation is higher than interest rates, whereas the value of an investment portfolio could potentially rise.

Putting it into practice

To help bring these considerations to life, here are three examples of what our Financial Planners might suggest to clients with different circumstances when deciding how much cash to invest. Remember, everyone’s situation is personal and so we will always provide advice based on your individual circumstances. If you would like to speak to one of our Financial Planners, please get in touch.

1. The Citrine family

The Citrines are high-earning professionals with a young family. Their outgoings include a £1m mortgage, school fees and nanny costs for their two children, and family holidays. They haven’t managed to save much of their income.

They recently received an inheritance of £250,000 that is sitting in the bank because they don’t know what to do with it. They want to use the money sensibly to benefit their children in the future, while possibly thinking about a house move in the near future.

Our thoughts: this family’s annual expenditure (including daily living, mortgage, school fees, nanny and holidays) is approximately £100,000. We would suggest keeping this equivalent sum in cash in the bank to provide them with a good buffer against the unexpected. It will be subject to inflation, but the family’s high costs and relatively insecure income from employment means a larger cash sum in the bank would be appropriate.

The other £150,000 could then be invested in a diversified investment portfolio to protect it against inflation:

£18,000 junior individual savings accounts (JISAs): £9,000 per child (the annual contribution limit) could be invested in a stocks and shares JISA to start off a savings pot for their university education; this money would grow tax free.

+

£40,000 individual savings accounts (ISAs): the Citrines could each invest £20,000 (the maximum annual allowance) in a stocks and shares ISA to maximise their tax-free allowance; this money would also grow tax free.

+

£92,000 diversified investment portfolio: the remainder of the money could be invested in a diversified investment portfolio with the aim of long-term growth. £20,000 per adult could be moved from a tax environment to a tax-efficient ISA annually.

2. Mr and Mrs Garnet

Mr and Mrs Garnet are in their mid-sixties and recently downsized their home, leaving them with £500,000 cash in the bank. They are nervous about the investment markets and are worried about ‘locking their money away’. They are considering gifting some cash to their adult children or buying a holiday home. They have a very good income from pensions and investments which covers their living expenses.

Our thoughts: the Garnets need to decide on their priorities and if they will be giving away money to children or buying a second home, that amount should be retained in cash. But as they have a secure income from their pensions and investments, there is no reason for them to retain more than that amount in the bank, as it is only being devalued each year in real terms by inflation. Should they need to increase their living expenses in future, for example to pay for care, they can switch their investments into more income-generating assets.

3. Mr Peridot

Mr Peridot is in his mid-50s and is still working. He has considerable pensions and investments but has not yet drawn down on his pensions. He has saved £200,000 over the course of the COVID-19 pandemic from reduced outgoings. He has adult children but no financial dependents.

Our thoughts: there would be no reason for Mr Peridot to retain any of his £200,000 cash sum in the bank, where it is subject to losses in real terms from inflation. We would encourage him to invest the £200,000 with inheritance tax planning in mind, making use of his various allowances. Read our article on gifting to family out of excess income for more information, or see all our articles on inheritance tax planning here.

As we have seen, there’s no simple answer to the question of how much cash in the bank is too much. The right decision will depend on many different factors, and this is why we recommend seeking advice from a qualified Financial Planner for expert guidance on your unique situation.

Find this useful? Read more about inflation: 

• Independent advice on how to invest your inheritance
• Protect your wealth from inflation video
• Do I need to protect my savings against inflation?