Never has it been more important to be aware of cash management in our financial planning. The last few years have seen a series of disruptions in global financial markets. When we think one issue is resolved, another seems to come along, which creates new uncertainties.
The financial crisis of 2008/9 forced governments around the world to pump prime economies by printing more money. Whilst this was needed, there would always be an inflationary price to pay at some point. Generally, governments handled this well, and markets settled down for a prolonged period. Stock markets rose as businesses recovered, and things appeared to be back to normal. Interest rates and inflation remained low, with many people benefiting from reduced mortgage payments.
Then, along came COVID-19, followed by the Ukraine war, and the only answer was for more government spending. Although the intervention was necessary, the threat of inflation became a reality as central banks rapidly increased interest rates to stop matters from getting out of control.
Since then, all global markets have been volatile and traditional portfolio allocation theory has been turned on its head. The rapid increase in interest rates has had a knock-on effect on Bond markets, which have seen their biggest fall in generations. Stock markets have also suffered, although, as in the past, the major markets have recovered quickly.
The role of cash management in financial planning
Investment portfolio theory states that assets should be allocated according to a person’s appetite for risk. In most cases, Equities would form the higher risk element and Bonds the lower. The higher the allocation to Equities, the higher the risk level, and vice-versa.
Historically, Bond investments have protected investors from the worst of the various Equity market corrections. Accepted retirement planning theory tells us that a pension pot or investment portfolio should be gradually de-risked as we approach retirement age. Targeted retirement funds work exactly this way by automatically changing the percentage allocation over time in favour of Bonds. Even if a stock market correction occurred just before retirement, the Bond element would remain firm, and income could be withdrawn from that part of a portfolio whilst waiting for equities to recover.
Cash hasn’t been a popular place to allocate funds within a portfolio for many years due to zero or even negative interest rates. This doesn’t, however, mean it shouldn’t form a part of anyone’s wider investment and income generation strategy.
The big advantage of cash holdings is they are usually liquid and instantly available. Yes, cash may not keep up with inflation, but sometimes convenience and not having to sell investments which are temporarily depressed in value is more important than asset appreciation. This is where an effective cash management strategy comes into play. Ensuring we have a sufficient balance of cash in our portfolios means income withdrawals can be switched from investment funds to cash funds.
For someone about to retire, it can be risky to rely on a fully invested pension pot. It’s prudent to have a cash reserve, which would last 1-2 years if there’s a good reason to delay drawing on pension investments. It is even better to have a diverse range of assets, which provides more choice when deciding where to withdraw funds from.
A good example in the UK would be ISAs, which are flexible and tax-efficient. For expats, capital investment products exist which can mirror these advantages, including being able to hold cash equivalent instruments which could be drawn on in turbulent times. The Spanish Compliant Investment Bond, Portuguese Investment Bond and French Assurance Vie offerings provide an ideal alternative to individual Equity, Bond and cash accounts. These vehicles offer all the benefits of investment diversity and are tax-efficient structures. Note, in this case, the word ‘Bond’ doesn’t mean the same as Fixed Interest Bonds as above.
In conclusion, although cash may not be as exciting as other asset classes and will almost always underperform inflation, cash management does have an important role to play in most people’s retirement planning strategies.
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