Cash is an integral part of any successful financial plan as it provides reliable growth and a layer of protection against financial shocks.

However, its strengths lie in the short term. Investing, on the other hand, may offer greater long-term returns, but it also carries inherent risk.

To ensure that you can meet your goals, it’s important to strike an effective balance between your cash savings and investments – one that ensures security but also financial prosperity.

Continue reading to learn more about the role of cash in your financial plan and how much might be too much.

Emergency cash funds offer short-term security against unexpected costs

Unexpected costs can seriously disrupt your finances.

Without an emergency fund, unexpected costs can erode cash you’d set aside for planned spending, like holidays or celebrations. In some cases, you may be forced to sell assets or rely on expensive borrowing to cover a large bill.

This is where the value of cash cannot be overstated. A consistent cash fallback option ensures that you will have enough liquid capital to absorb surprise costs without sacrificing financial stability.

It’s recommended that you keep an emergency fund with three to six months' worth of essential living costs, including mortgage payments, utilities, and household expenses. However, you could keep a larger sum if it makes you feel more comfortable, or if you have any large expenses planned in the next two years.

Equally, if you’re retired and draw from an invested pot of assets to fund your lifestyle, it may be beneficial to hold a cash reserve equal to two or three years’ worth of income. This means that, during a market dip, when you would need to sell a larger portion of your investments to maintain the same income, you could rely on cash savings to pay your expenses.

Ultimately, this could protect your investment pot and prevent you from spending your retirement fund too quickly.

Whatever the reasons for holding cash, placing the funds in an easy access savings account gives you the flexibility to withdraw them immediately to pay for unplanned expenses.

Cash savings interest is liable for Income Tax

While an emergency fund is important, cash savings face significant tax drawbacks, which could impede your ability to generate growth.

This is because the interest from cash savings forms part of your taxable income.

In both Jersey and Guernsey, savings interest is subject to Income Tax for the year in which the income arises.

As such, if you hold excessive amounts of cash, you could lose a significant portion of the growth to Income Tax. When it comes to investing, the rules are slightly different.

Dividend income is liable for tax, but investment growth is tax-free

Investments may be more tax-efficient than cash savings because, while you pay Income Tax on dividends (a portion of a company’s profits paid to shareholders), the capital growth you see from your investments is tax-free.

In Jersey and Guernsey, the rules for dividends are similar to those for savings interest – most dividends are considered part of your taxable income and are liable for Income Tax.

However, unlike cash, if your investments increase in value, this growth is tax-free. You could later sell your investments to release the wealth and fund your lifestyle and important financial objectives.

Consequently, if you already have a healthy emergency fund and savings for immediate goals, investing your additional wealth could reduce the Income Tax you pay.

Investing could generate greater long-term returns than cash

While cash offers reliable growth, historical data shows that investments could generate higher long-term returns.

For example, if you kept £10,000 in a savings account with an annual interest rate of 4%, you would generate 20% compound growth across five years. This is a gain of roughly £2,210.

However, if you had instead invested £10,000 in the FTSE All-Share index for five years, from 1 January 2021 to 1 January 2026, it would have grown by 44.73% – giving you a return of £4,473 – according to London Stock Exchange (LSE) data.

While past performance doesn’t guarantee future returns, historical data suggests that investments could provide greater returns than cash in the long term. Despite this, it is important to note that investing always carries fundamental risk.

While investment risk is unavoidable, a strong, diversified, and well-managed portfolio aligned to your goals can help to ensure steady and stable growth over time.

It is important to strike a balance between cash and investing

A successful financial plan doesn’t rely on cash savings or investments alone; it is a delicate balance between the two.

Cash savings play a valuable short-term role. They provide financial security, preparing you for unexpected expenses, such as emergency repairs. Cash is also useful for planned short- to medium-term spending on holidays or a new car, for example.

Over the long term, however, investing generally offers far greater growth potential. Additionally, reducing the amount of cash you hold could help you mitigate your Income Tax liability.

As such, finding a balance between cash and investments could improve your ability to work towards your financial aims now and in the future.

Get in touch

If you’d like help developing your financial strategy, your Rossborough Financial contact can help.

You can email enquiries@rfsl.co.uk to book an appointment with your adviser today. Alternatively, call 01534 502000 in Jersey or 01481 747940 in Guernsey to set up a meeting.

Please note

This article is for general information only and does not constitute advice. The information is aimed at individuals only.

All information is correct at the time of writing and is subject to change in the future.

Please do not act based on anything you might read in this article. All contents are based on our understanding of current tax legislation, which is subject to change.

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.

Rossborough Financial Services Limited is regulated by the Jersey Financial Services Commission under the Financial Services (Jersey) Law 1998 and licensed by the Guernsey Financial Services Commission.