Feb 20, 2009

A place for cash

It is always a good idea to have some money set aside in case of emergencies. Enough to cover three months’ living expenses is often a rough guide to how much you may need. And for most of us a bank account is a safe place to keep cash. It is also useful for short term savings – putting money aside for a new car,a holiday or the deposit on a house. However, with a long term investment, the security of cash has to be balanced against the risk that it will not generate the level of returns you are hoping for.

The spectre of inflation
A potentially more serious threat to your bank account is the damage that inflation can cause. Rising prices could mean that the real return on your savings is very small. For instance, if your account pays 8% but inflation is 6%, you are only making 2% in real terms. You then have to take tax into account – for an investor in the highest tax bracket, this will result in a negative real return. If inflation is higher than 6%, as it is at the moment, the effect on your real returns will be even worse. A reduction in interest rates would also cut into the returns on your savings.

Read: Strategies for successful investing>>



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