The forgotten asset class – using cash effectively

Cash is often treated as the place investors leave money when they are not sure what to do next. That undersells its role. Used deliberately, cash can be an active part of a financial plan: a way to mitigate volatility when investing into markets, a tax-efficient home for savings through an ISA, and a practical reserve for people drawing income from their investments.

For many years, investors probably overlooked cash in their overall portfolios – little surprise when interest rates were at or near zero for many years. But today, rates are higher, and the impact of ignoring cash is therefore higher too.

Feeding money into volatile markets

When markets are unsettled, holding some cash can help overcome one of the biggest barriers to investing: the fear of putting a lump sum in just before prices fall. Drip-feeding money into markets, sometimes called pound-cost averaging, allows investors to buy gradually over weeks or months. It does not guarantee better returns than investing all at once, but in volatile markets, it can reduce the pressure of trying to time the perfect entry point.

This makes cash a useful tool. It gives investors a plan for moving from the sidelines into long-term assets, while still taking advantage of market weakness when it appears. For cautious investors, that can be the difference between remaining permanently underinvested and steadily building exposure to assets with stronger long-term growth potential.

Making use of an ISA allowance

Cash can also be useful inside an ISA. The annual ISA allowance gives savers and investors a valuable tax-efficient wrapper, and cash can provide flexibility within that wider plan. For some people, a Cash ISA may be suitable for short-term goals or an emergency reserve. For others, cash held temporarily before investing through a Stocks and Shares ISA can help them use the allowance before the tax-year deadline while still allowing time to decide how best to invest.

From April 2027, the overall ISA allowance will remain £20,000 per year, however the Cash ISA limit will reduce to £12,000 for those under 65. Therefore investors can either invest £12,000 in a Cash ISA and the remaining £8,000 in a Stocks & Shares ISA, or they can invest the full £20,000 in a Stocks & Shares ISA.

Within a Stocks & Shares ISA, cash left uninvested will be subject to a 22% tax charge on any interest earned. Money market funds, including the Royal London Short Term Money Market Fund, are now classified as ‘cash-like’ assets. Importantly, this does not change their eligibility. They remain fully investable within a Stocks & Shares ISA. But treatment does change:  a Stocks & Shares ISA 100% invested in money market funds may be treated as ‘cash-like’ and therefore subject to a 22% tax charge. However, where money market funds are held as part of a broader, diversified investment strategy alongside other assets such as fixed income investments, including short-dated bond funds, or equities, then they will continue to benefit from the usual tax-efficient ISA  treatment. Please note that these new rules are subject to consultation and confirmation, with an expected roll-out on 6 April 2027 [1].

Supporting income drawdown

Cash has another role for people taking income from pensions or investment portfolios. In drawdown, market falls are more dangerous because investors may have to sell assets at depressed prices to fund regular withdrawals. Keeping a cash reserve can help meet near-term spending needs without forcing sales during periods of volatility.

This is the logic behind a cash ‘bucket’ or income buffer. By holding enough cash for planned withdrawals, investors can give the growth part of their portfolio more time to recover after difficult markets. Cash will not remove investment risk, and holding too much can reduce long-term returns, but the right reserve can make drawdown more resilient and less stressful.

Avoiding cash drag

Cash may or may not be an active asset allocation decision, but it is invariably part of the overall portfolio. When cash sits outside the market, the rates offered by platforms or fund providers can be modest – at the end of August 2026, rates on platforms were typically 2-3% depending on product and balance, while the Royal London Short Term Money Market Fund yielded just under 4%. That does not come without risk, but the lower return on cash balances can create a drag on overall portfolio returns, particularly if the balance is larger or held for longer than intended.

We believe investors should therefore look for ways to make cash work harder by seeking an appropriate return while it is waiting to be deployed, without treating it as a long-term substitute for invested assets.

How long is your cash?

When looking at cash as part of a portfolio, not all types are equal. We look at cash as a spectrum (figure 1). At one end is cash itself: bank deposits or instant-access balances that are designed to be available immediately. The next step is liquidity management, where investors use products intended to preserve capital and provide access at short notice. Known as money market funds, these pool investors’ money into low-risk, high-quality short-term assets. Under FCA guidelines, these need certain attributes to be recognised as qualifying money market funds [2] – these relate to quality of the assets held, maturity of those assets, and providing daily liquidity for investors. However, these are investments, not deposits. In theory, money market funds should not produce negative returns for investors, but this cannot be guaranteed.

Finally, there are longer maturity funds. These will typically have a large proportion of their assets in the same investments as money market funds, but then look to enhance return by adding other investments, typically by adding a degree of credit or interest rate exposure. This means that while these target a higher return, they also carry a higher risk.

In effect, making no decision on cash exposure will leave this placed in the first bucket: this may be right for a client as this typically guarantees return of cash. But this guarantee has a cost in terms of potential return.

Figure 1: Risk / return spectrum for different ‘cash’ choices

Source: RLAM. For illustrative purposes only

For many investors, a move from deposits into money market funds will be as much risk as they are willing to take for their cash exposure. We find that investors give greater consideration to enhanced return when they have a longer timeline – for instance, when there are known liabilities or expenditure over the course of 12 months, an investor may not want to put some of that balance into equity markets given the relatively high short-term volatility this can entail. But conversely, leaving everything in a guaranteed deposit may mean accepting a low return. Through a process known as ‘liquidity laddering’, cash can be spread across a number of liquidity and short-term fixed income funds to achieve the preferred mix of risk and return, while avoiding the higher risk associated with other asset classes.

Make an active choice

Cash is an intrinsic part of every portfolio, and is often a short-term resting place while an investor decides whether to withdraw funds or move into other asset classes. But it should still be a conscious decision. By matching cash holdings to the investor’s time horizon, liquidity needs and appetite for risk, cash can do more than sit on the sidelines: it can help support resilience, preserve flexibility and make the wider portfolio work more effectively. Investors should therefore review where their cash is held, how long it is likely to remain there, and whether a more deliberate liquidity strategy could help it work harder without taking unwanted risk. 

[1] https://www.gov.uk/government/publications/fiscal-events-2026-factsheets/isa-reform-2027-anti-circumvention-rules-factsheet
[2] https://handbook.fca.org.uk/glossary/G2422

For professional investors only.  This material is not suitable for a retail audience. Capital at risk. This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. Reference to any security is for information purposes only and should not be considered a recommendation to buy or sell.

The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change. Forward looking statements are subject to certain risks and uncertainties. Actual outcomes may be materially different from those expressed or implied. 

The Fund is a sub-fund of Royal London Bond Funds ICVC, an open-ended investment company with variable capital with segregated liability between sub-funds, incorporated in England and Wales under registered number IC000797. The Authorised Corporate Director (ACD) is Royal London Unit Trust Managers Limited, authorised and regulated by the Financial Conduct Authority, with firm reference number 144037. For more information on the fund or the risks of investing, please refer to the Prospectus or Key Investor Information Document (KIID), available via the relevant Fund Information page on www.rlam.com.

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