People are increasingly parking large sums of money in cash, unaware that a combination of inflation and tax slowly take it away from you. There is therefore one truth that cannot be overlooked – cash is not king.
Many people hesitate to invest because markets fluctuate in the short-term, which can make investing feel risky. This leaves many opting for the “safer” alternative – leaving large sums of money in cash where the value “cannot go down.” However, a combination of inflation and tax also means your money cannot grow in real terms.
Inflation reduces purchasing power
You have probably already felt the pressures of inflation on your day-to-day expenses, but parking your money in cash makes the picture bleaker. The logic goes that as prices rise, the purchasing power of an asset diminishes over time – particularly your cash. In the early years of saving, this erosion of value is modest. However, it is easy to forget its compounding effect and before you know it, inflation has meant that your purchasing power has now halved in value.
Note: It is worth keeping some cash as an emergency fund for unexpected costs or a sudden reduction in income – typically three to six months of your monthly expenditure – before investing your money.
Rates barely beat inflation
You might even say “but a good savings account can pay me a good rate of interest.” It may seem particularly attractive that a cash account can offer interest of between 3% and 5%, compared with an investment portfolio that cannot guarantee returns and will fluctuate in value day-to-day.
But the reality is that this rate of interest just about keeps pace with inflation. This explains why higher than average inflation over the past four years has been accompanied by higher interest rates. However, once inflationary pressures ease, interest rates generally tend to fall too.
Tax accelerates the damage
The picture becomes worse once that interest has been taxed. All higher rate tax-payers get a £500 Personal Savings Allowance, allowing them to earn that amount of interest tax-free. Anything above this threshold, however, is taxed at 40%, meaning only 60% of the interest gained actually goes to you.
In this light, investments can enhance tax-efficiency, enabling access to capital gains tax allowance, dividends allowance and typically benefiting from lower tax rates.
Use your ISA allowance
One easy way to combat this is to utilise your £20,000 annual ISA allowance, which acts as a neat tax shelter. Any savings beyond that threshold become significantly harder to protect from taxation. And like many things in finance, ISA allowances do not roll over into the new tax year – if you do not use them, you lose them.
Tip: By investing early in the tax year, you give your money more opportunity to grow in 2026/27.
Despite short-term fluctuations, it is worth remembering that investing your money offers far superior potential returns in comparison to cash – this is referred to as ‘risk premium’ (see chart).
The importance of investment risk
That is providing you follow some basic investment guidelines. First, that you invest with a long-term horizon (5+ years) to ride out market volatility, and second, that you adopt a diversified investment approach to counteract any specific sector or geographical risks.
[i] Do you want to watch your money grow rather than deplete in value? Call 03300 564 446 or get in touch via our contact form to find out what your investment options are.
This article is for general information purposes only and does not constitute financial advice or a personal recommendation. Past performance is not a reliable indicator of future results. Investments can rise or fall in value, and you may receive less than you originally invested. Tax treatment depends on individual circumstances and may change in the future.
