It’s easy to forget that inflation erodes the purchasing power of money. As the prices of goods and services rise, we can buy less of what we used to be able to afford. Although the rate of inflation is low today, we expect it to increase gradually over the long term as the economy recovers and demand from businesses and consumers picks up.

Interest rates are at record lows and even negative in some countries. They are unlikely to increase any time soon as central banks maintain monetary policies that can stimulate growth. Therefore, the returns from cash savings and short-term government bonds are likely to be negligible for the foreseeable future – and negative after taking inflation into account.

Holding cash is an active choice, and it’s important to consider the decision against the opportunity cost of investing. On rare occasions cash outperforms other asset classes, but only when the conditions are just right. Over the long term, cash is often an unattractive investment, which may drag down a portfolio’s returns as the economy and markets recover.

Cash appears to be the most straightforward store of wealth. Yet there’s more to think about – from the risk of missing out on higher potential returns from other asset classes to the opportunities available to reflect your personal values.

The money funds using ESG criteria invest in commercial paper and other private instruments. These funds specifically look at companies that meet or are adopting high standards in ESG terms.

There is significant demand for ESG money market funds, which is driving growth in this sector and has led to an increasing range of funds available for private investors and corporate treasurers.

As more of us realise our decisions make a difference, sustainable investing is becoming increasingly popular. It’s now possible to ensure that the cash allocations in your portfolio reflect your personal values by choosing money market funds that incorporate environmental, social and governance (ESG) factors into their investment decisions.

The core investment objectives of money market funds are to preserve capital and provide liquidity, so their investment approach naturally aligns with certain ESG principles. However, recently money funds have begun looking at these factors more proactively.

Money market funds incorporating ESG factors are attracting large inflows

Some investors like to hold cash in their portfolios so that they have dry powder to put to work as soon as they spot an opportunity. Yet the reality is that waiting for an attractive entry point often leads to inertia. We end up doing nothing because we’re worried about making the wrong decision. During periods when markets are rising, it may be tempting to wait for a good entry point by keeping your cash rather than investing. But when markets are falling, many investors feel uncomfortable investing in case they suffer immediate losses. This pattern of behaviour can mean that our money remains uninvested.

Many of us think about the various assets and investments that make up our wealth in different ways, and the same goes for any cash savings. It’s a common cognitive bias called mental accounting, and it can affect our financial behaviour in unhelpful ways. One side effect is that many people end up with a higher total allocation to cash than they think.

It’s important to consider all your cash holdings together with your investments, and not to segregate them into separate buckets. You’ll then have a more accurate picture of your overall asset allocation, which can help you make better investment decisions as you stay focused on your long-term financial goals.

Source: Fitch

Rather than selling investments, you could consider borrowing against the value of your portfolio. You retain control of your core portfolio and gain immediate access to funding. 

Meanwhile, some of the economic conditions that are bad news for cash have the opposite effect on debts. They include inflation, which erodes the value of loans over time in the same way that price rises reduce the purchasing power of your cash.

Cash and cash-like investments (such as short-term government bonds and commercial paper) can offer a source of comfort during periods of uncertainty in case you need money quickly. However, with interest rates at record lows, now might be a good time to take advantage of a loan if you need to free up some liquidity.

Over the long term, cash tends to underperform most other asset classes, and investors could miss out on these potential returns if they  don’t invest. When considering entering a market a systematic and disciplined approach can be adopted, which involves investing cash gradually and being fully invested as much as is practically possible.