How investing works
Cash as an asset class
By Michael Trudeau
Article 4 of 4
Cash as an asset class
Find out how cash can benefit your investment portfolio.
Cash is an integral part of building any investment portfolio. It is the only asset class that doesn't pose any capital risk – meaning that you won't lose any actual money by placing your money in 'cash'.
Cash helps to protect your money. If you're uncomfortable with losing too much money, you can keep much of your portfolio in cash and then diversify into other, riskier, asset classes. Remember the risk-reward trade-off though – the more you have in cash, the lower returns you might receive.
However, that's not to say that there aren't any risks with cash – you could see the spending power of your money fall if inflation is higher than the interest rate you receive. This is known as inflation risk.
Find out more: Which? investment portfolios – we have created a unique set of investment portfolios that can help you find the right mix of assets for you
In the 2016-17 tax year, you can place up to £15,240 into a cash Isa and can top up your Isa account annually (the limit will increase to £20,000 at the beginning of the 2017-18 tax year). Any gains you make from the interest you’re paid are tax-free.
But remember that if you want to move your Isa to a higher-interest product, apply to transfer it rather than taking out the money and re-investing it yourself. This is because if you withdraw your money and then re-invest it during the same tax year, you'll be using up all or part of your tax-free allowance for that tax year.
Which? Money Compare tables: Best Rate cash Isas – check out the latest rates on tax-free savings accounts
Once you have used up your cash Isa allowance, you can also place your money in a taxable savings account. In choosing one, you need to look carefully at its features as well as the interest rate it pays.
Instant or easy-access accounts suit those who may need to withdraw money at short notice. They are suitable accounts for rainy day funds but don't offer much, if any, growth above inflation.
Higher rates of interest are often offered to savers when they open a new account. These bonus rates commonly last for 6-12 months, reverting to a lower rate thereafter, so it is worth making regular checks to confirm the rate you will receive.
Which? Money Compare tables: Best Rate savings accounts – check out the latest rates on savings accounts
National Savings & Investments (NS&I)
NS&I is a government-backed savings and investments service, offering a range of products to help you save money. As it’s run by the state, it means that 100% of your savings are fully protected, better than the £75,000 (reduced from £85,000 on 1 January 2016) that the UK’s Financial Services Compensation Scheme provides should a bank go bust.
NS&I offers a range of products, from premium bonds to simple cash accounts, children’s savings products and the popular inflation-linked savings certificates. NS&I doesn’t generally provide market-beating interest rates on its products but, if it’s complete safety you’re looking for with your cash, they could be a good option.
Find out more: Are my savings safe? – see how your savings are protected
Money market funds
Money market funds are collective investment schemes, usually in the form of unit trusts and open-ended investment companies (Oeics), which invest your money in cash or equivalents to cash, like short-term loans to the government (known as Treasury Bills) that pay a fixed rate of interest (like a gilt).
There are a couple of advantages to investing in a money market fund. Firstly, managers of these funds investment in many different types of cash-like products, and you can therefore diversify your portfolio away from having all of your money tied up in just one savings account or cash Isa.
Also, if you are building a portfolio of investments, investing in a 'cash' fund can allow you to easily keep a check on its performance along with your other fund investments.
However, with money market funds, you could lose some of the capital value of your money, unlike a deposit account or cash Isa. You're also charged an annual management fee, usually around 0.75%, which, in a low-interest environment, can reduce any returns the fund makes.
Find out more: Different types of investment – find out more about unit trusts, Oeics and fund charges
- Last updated: February 2016
- Updated by: Michael Trudeau