Our Thoughts

What a difference a year makes! If you read Part 1 of this piece (the last edition of City Life), I was writing about how inflation erodes the value (purchasing power) of cash; the article was typed in June of 2021, inflation was virtually non-existent, but expected to ease back up to 2% p.a. Now however, in this crazy world in which we live, we’re seeing short-term inflation soaring into double digits and can only dream of 2% p.a.

Do we expect the current situation to continue? All the experts say no. They claim that what we’re seeing is very much a combination of short-term circumstances that have come together to create ‘the perfect storm’; I don’t like this phrase, but in this situation, it seems entirely warranted.

Anyway, back to Part 2…

Imagine we are lucky enough to have some cash stashed away or can save on a regular basis (remember, the ridiculous cost rises that we’re currently seeing are supposed to be short-term!), how much should we aim to have in our bank, building society, or NS&I Premium Bond account?

As ever, with all my answers, it depends. Having the right amount of cash is a balance depending on your personal circumstances and spending needs. Everyone though, would benefit from having three separate ‘pots’ of cash; they certainly don’t need to big; they just need to be big enough. I’m going to refer to them as Current Account, Emergency Fund and Savings.

Current Account. Allowing a current account to become overdrawn can be an extremely expensive way of borrowing money. Some of the charges that banks and building societies make for an unauthorised overdraft can be eye watering. Therefore, if we can protect ourselves from those charges that can only be a good thing. Our aim with the current account is that after the last bill has been paid each month, there’s just enough left to cover the next bill (or two) that usually come out after our next monthly income has been received. Consider it a little safety net.

Emergency Fund. This is the bigger safety net. The idea behind this pot of money is that it sits there only in case of emergencies; there’s no plan to use it, imagine it has a piece of perspex over it that states “In case of emergency”. If you’re lucky enough to be able to have the ideal-sized Emergency Fund, it should be large enough to cover between four and six months’ worth of essential spending (essential bills and spending only, not ‘nice to have’).

Finally, the third pot: Savings. This is the money that we can use for all planned ‘big ticket’ spending over the next six to twelve months (holidays, home improvements, car, wedding, etc.). Things that can’t be paid for out of our normal monthly income.

If you’re fortunate enough to have these three separate pots of cash, then you’re well on your way to being in a really strong financial position and achieving a balanced approach to saving and investment.

Time to get a coffee!

David

David Hinch is the Managing Director of David Burnell Financial Services.

So, the day has finally arrived. Well, technically speaking, it arrived two days ago. I remember the discussion well, and I’m sure Nick Smith (City Life) said “Don’t worry, the deadline’s months away; you’ll think of something to write”. Oh dear.

Apparently, I agreed that I would write a series of articles to help City Life’s readers (hopefully that’s you), start thinking about investment planning and what it means. Blimey.

Okay, let’s dive in and start with a question I ask everyone who tells me they want to invest some money: “How much cash have you got?”

This isn’t some sneaky question to try and get them to invest all of their money, far from it. It’s to help make sure that they can afford to even consider investing money. It’s really important that before a single £ is invested, there’s enough cash in the bank or building society. So how much is enough?

Having an appropriate amount in cash is really important, but also a bit of a balancing act. Too little cash, then money that’s been invested may need to be withdrawn at a time when market conditions are less than ideal; too much, and you’re actually losing money. Losing money with cash? Surely, I’m talking rubbish? Sorry, I’m afraid it’s true.

Interest rates (the amount the bank or building society will pay you for having cash in your account) are really low; actually, they’re at an historic low. But at least they give you something, right? 0.1%? 0.2%? If you’re really lucky it might even be 0.5%. Great. Actually, that’s not great. Why? Because the rate of inflation (the actual cost of living) is higher than that.

As each year goes by, the cost of pretty much everything that we all buy, and pay for, goes up. Sometimes it goes up really quickly (ask a builder about the cost of cement at the moment), sometimes more slowly, but for planning purposes, we should think about the cost of living going up by 2% every year.

So, the general cost of ‘stuff’ goes up by 2% every year, and let’s consider a fixed amount of money, say £1,000 (to help keep the numbers easy, I’ll ignore the small amount of cash interest it may earn, and assume that the 2% price rise comes in one go, at the beginning of the year).

Imagine a cup of coffee costs £1 (I wish). In the first year you can buy 1000 full cups with your £1000; in the second year you can buy 980 full cups; in the third year you can buy 960; the fourth year it’s 941 and in the fifth year it’s 922. Only 922 cups in the fifth year, with the same £1000. Even for such a small inflation percentage, that’s a significant decrease in the purchasing power of your £1000. And yes, I know, even I probably wouldn’t drink that much coffee in a year.

Next time, I’ll explain how to work out what an appropriate amount of cash in the bank or building society might look like.

I think I need a coffee.

David

David Hinch is the Managing Director of David Burnell Financial Services.