Is cash an asset class?
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.
If you're uncomfortable with losing 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.
How can I invest in cash?
Keeping cash in savings accounts and Isas is the least risky way to generate returns, but you should ensure you have enough instantly-accessible savings to cover at least three months of living costs before starting to invest.
In the 2021-22 tax year, you can place up to £20,000 into a cash Isa and can top up your Isa account annually. 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.
Given that investing is a long term strategy - five years at a minimum - it makes sense to consider fixed-rate Isas and savings, where interest rates are typically higher.
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.
What is 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 £85,000 that the UK’s Financial Services Compensation Scheme provides should a bank go bust.
NS&I offers a range of products, from simple cash accounts and children’s savings products. 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.
Its Premium Bonds are particularly popular. These offer the chance of winning between £25 and £1m each month instead of paying interest, and while you can't hold them in an Isa, winnings are tax-free.
You can only invest up to £50,000 in Premium Bonds, so they may be less useful for investors with large portfolios.
- Find out more: are my savings safe?
What are 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).
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, which, in a low-interest environment, can reduce any returns the fund makes.
- Find out more: different types of investment