The hidden cost of holding too much cash

Government policy, inflation and interest rate uncertainty are reshaping the landscape for savers. While cash remains important for short-term needs and emergencies, holding too much of it can erode wealth over time. Our special contributor and Daily Telegraph investment columnist David Stevenson explores the topic in more detail.

You may not always like what politicians tell you, but when it comes to savings, I tend to think actions speak louder than words. Politicians of all stripes love to say how important they think savings are, but their constant fiddling with the rules, regulations, and rates, I think, speaks to a very convincing narrative keep changing the tax regime so that savers are confused.

Take the tax rate on savings. Throughout most of the 1970s the UK laboured under very high tax rates on savings. While the top rate on earned income was 83%, there was an additional 15% Investment Income Surcharge on “unearned” income above a certain threshold. Then in the 1980s, the Conservatives under former Prime Minister Margaret Thatcher simplified the tax take into two main bands of 25% and 40% but they also required banks and building societies to deduct tax from interest at source before paying you. Then the tax wrappers, Tax-Exempt Special Savings Accounts (TESSAs) and Personal Equity Plan (PEPs), were introduced over the next few decades, while in 2016 the Personal Savings Allowance was introduced for savings, which stopped banks deducting tax at source and allowed up to £1,000 of savings income to be paid tax-free.

The history attached to TESSAs, PEPs and Individual Savings Accounts (ISAs) – the biggest tax wrappers for savers – is much, much longer (and I’ve discussed it in previous articles) but it also follows a familiar arc onerous taxation in the 1970s, more liberal rules over the next few years, and then, bit by bit, the rules get changed again. 

The end result is that the writing is on the wall now for the cash ISA from next year there’s a cash cap coming. As of April 6, 2027 for those readers under 65, the amount you can put into a Cash ISA will be capped at £12,000 per year, although the overall ISA limit remains £20,000, which means you could still put £12,000 in Cash and the remaining £8,000 in a Stocks & Shares ISA. Just to make things really complicated, there will be an exception – if you are 65 or over, the full £20,000 Cash ISA limit remains available to you.

And if all that wasn’t confusing enough, the government is also consulting on options for cash held within a Stocks and Shares ISA, such as cash that may be held between investments. The government is worried people will simply put their full £20,000 into a Stocks and Shares ISA and leave it as cash to earn interest tax-free. Thus, HMRC is consulting on a plan to tax the interest earned on cash held within a Stocks and Shares ISA or an Innovative Finance ISA. A similar exercise is said to be underway for cash held in a Self-Invested Personal Pension (SIPP). While there is no confirmed plan to tax SIPP interest yet, the treasury is said to be monitoring whether this cash is being used as a “shadow” savings account rather than for retirement investing.

I’d wager that over time governments of all stripes will progressively chip away at the cash element of SIPPs and probably increase tax rates on savings. The logic behind these moves is simple public sector borrowing is high, with constant deficits, and the cost of funding that debt has been increasing markedly in recent months. Governments, Conservative and Labour led, have also been very clear that the various tax wrappers should be focused on investing scarce domestic capital in investment (stocks and shares) rather than in cash savings.

What next for interest rates

These policy developments also coincide with a very volatile interest rate environment. Until the end of February of this year, the expectation of most observers was that the Bank of England might lower interest rates from their current 3.75% to, perhaps, according to some City analysts, 3% or less.And then along came the Middle East conflict and everything changed. Now most City observers think that UK interest rates might actually increase. One clue comes from UK 2-year gilt yields, which act as an indicator for the likely direction of interest rates. The chart below from the web site Trading Economics shows how that yield has changed markedly in just a few weeks. Prior to the Iran war, this yield curve was suggesting  2 year gilt rates below 3.5% was sustainable, now its back above 4.5% which implies an increase of as much as 1% in UK interest rates.

This next chart shows, via a composite of market indicators and analysis, how interest rate expectations have changed radically in just the last few months – moving up a whole 100 basis points or 1%.

Don’t overdo the sensible need for a cash reserve

In these circumstances, it’s little wonder that most investors and savers are a little confused interest rates keep moving around, and savings rates tend to lag those changes while the government keeps changing the goal posts. What to do? I’d make four very simple observations.

The first is that savings and investing are very different things and that you shouldn’t overdo the savings but simply make sure you have enough. The rough and ready reckoner is that you have anything between three and six months’ spending money as a cash buffer for future unknowns. I’ve seen some savers who have multiples of their spending needs, some enough to fund them for many years – all kept in an instant access account for many years. This makes no sense at all, except if you have a very specific need for the cash, such as saving for an imminent house purchase. Why am I so sceptical about holding cash for a very long period of time? Simple observation number two.

Inflation destroys cash wealth. For the 45 years since 1980, inflation beat the typical instant-access savings rate in roughly 30 of them. Cash has preserved nominal value, but chronically failed to preserve purchasing power. The chart below puts this observation within a graphic form and is based on Moneyfacts data.

It shows how, for long periods of time, the real rate of return on cash (savings yield minus inflation rate) has produced real negative returns. To put it another way, the purchasing power of your savings cash is constantly being eaten away by the UK’s inflation rate – which tends to be higher than most other Northern European nations (who boast lower inflation rates).

To see this point for yourself pop along to the Bank of England’s inflation calculator online here. Tap in £10 in 2000 and notice how what cost you £10 in 2000 would now cost you £19.26 which is a 92% change in value with an average inflation rate of 2.54% which is below the long term average for the UK. As an aside, since 1945 the average long term inflation rate for the UK is 4.58% according to the Bank of England.

This brings me nicely to my third point cash is not king over the long term, stocks are. Every year a small group of UK academics get together to compile the UBS Global Investment Returns Yearbook 2026. This is the definitive source of long-term data (from 1900 and in some cases before then) on various geographical markets and asset classes. 

The message from every single one of these reports for the vast majority of nations (including the UK) and for the vast majority of periods, is that equities/stocks/shares beat cash by a country mile as well as bonds in most cases, even if past performance is not a reliable indicator of future performance.

Here’s the 2026 analysis which starts with the observation that equities outperformance (based on US data) has been striking

“Equities have outperformed bonds, bills and inflation since 1900. An initial investment of USD 1 grew to USD 124,854 in nominal terms by end-2025. Long bonds and Treasury bills gave lower returns, although they beat inflation. Their respective index levels at the end of 2025 were USD 284 and USD 69, with the inflation index ending at USD 38. This outperformance is not just a US phenomenon. The Yearbook shows that equities were the best performing asset class in all 21 Yearbook countries with continuous investment histories. Meanwhile, bonds beat bills in every country except Portugal. This pattern supports one of the lasting laws of finance – the law of risk and return – and the idea that risk-bearing should carry an expected reward.”

I’ll finish with my last observation, aimed at those investors who like to keep mountains of cash in their SIPPs and Stocks and Shares ISAs in case they can time markets better or avoid the nastiness that results from geopolitical events.

A recent analysis by UK stockbroker Killik & Co from just after the start of the Iran crisis shows that across a range (25) of major geopolitical crises, the average market drawdown has been around 4.7%, with markets typically reaching a bottom after roughly 19 trading days and recovering within around 40 days. Even some of the most severe events, such as 9/11 (the terrorist attacks in New York on 11 September 2001), saw markets recover relatively quickly once the initial shock had passed. The chart below helps demonstrate that point.

This Killik & Co analysis also takes aim at those investors sitting on cash trying to time the markets and get the right entry point to move from cash into riskier equity investments. They observe that most market recoveries often occur quickly and unpredictably. Data from the FTSE All-Share Index (the market-capitalization-weighted index representing the performance of roughly 98% of the UK equity market) shows that between 2010 and 2025, remaining fully invested produced an annualised return of 7.6%. Missing just the 10 best market days over that period reduced returns to 4.5% and missing the 40 best days resulted in negative returns overall. Importantly, many of these strong recovery days occur shortly after periods of market stress.

So, to conclude, read the policy writing on the wall. There are more and more limits likely to emerge holding cash within a tax efficient structure. You absolutely should be holding cash for everyday essentials and emergencies, but probably at the right level and over right period.

That’s because inflation can severely erode the value of your cash wealth, and for most years there is a very good chance that your real return on tax-advantaged cash savings will be a negative return after inflation – remember that most investors think the UK will suffer from elevated inflation in the next 12 months following the Iran war.

The best returns over the long term come from holding equities, living with the volatility and ignoring geopolitical events (and sitting tight). And don’t hold too much cash in an investment wrapper just because you think you can perfectly time the markets. You probably won’t – inflation will eat away the value of the cash, and you’ll miss upside market opportunities.

Please remember that when investing, your capital is at risk. The value of your portfolio with Moneyfarm can go down as well as up and you may get back less than you invest. Past performance is not a reliable indicator of future performance. The views expressed here should not be taken as a recommendation, advice or forecast. Investing is usually for the long term, but it depends on the circumstances of each individual. If you are unsure investing is the right choice for you, please seek financial advice.