When might cash not be king but rather a liability or risk? The Brand Financial Training team look at the regulations around holding cash in a client’s portfolio.
A key part of the role the financial advice process is to ensure that the client’s risk profile has been appropriately assessed.
The process for this will be second nature to a number of readers; it involves an assessment of the client’s attitude to risk, tolerance for risk and capacity for loss. Most, if not all, will involve the completion of a questionnaire or profiling tool. Customer interaction with the results is key to coming up with an overall appropriate asset allocation.
Historically, regulators have always cautioned against clients being exposed to excessive risks, or risks that they do not fully understand. However, in some circumstances, the reverse can be just as much of an issue. Research published by the Financial Conduct Authority in 2021 indicated that 8.6 million Brits held cash savings of over £10,000 and risked having the value eroded by inflation. The regulator stated a target of persuading a fifth of those to invest their surplus funds by 2025.
In general terms, there may be a debate to be had about the appropriateness of that broad brush approach.
Firms are also expected to encourage clients to retain accessible cash savings of between 3-6 months’ worth of expenditure and in many cases £10,000 will not, or will only barely, cover that. However, conversely, it is a principle preached by any self-respecting financial adviser that excessive hoarding of cash where it is not required will, in the long-run, cost you money.
With that in mind, the regulator has recently introduced the cash warning rules. The regulations, which came into force on 1 December, require pension providers to check on a three-monthly basis, whether clients have held more than 25% of their portfolio in cash, or cash-like investments, for a period of more than six months.
Other conditions to be met include that the absolute value of the cash holding must be more than £1,000 and the client must be more than five years away from either the normal minimum retirement age or any protected early retirement age they may have. This is in recognition of the fact that for some clients, as they approach retirement, protecting against market volatility becomes more important than targeting capital growth.
In general, given the long-term nature of pension investment, targeting capital growth is essential for those wishing to enjoy a good standard of living in retirement, even if it comes with an increased degree of short-term volatility. It is, though, an inescapable fact that many an adviser has had their hands full over the last 12-18 months trying to persuade jittery clients that selling down their holdings to invest in cash-based products is not in their long-term interests. The new warning requirement, coming as it does from the provider rather than the adviser, should hopefully help to lend some weight to such assertions.
The timeframe given for providing the cash warning is not absolute, but the FCA has indicated 3 months from the date of the assessment as what it would consider to be reasonable. Where a warning has been issued, the provider is not required to issue another one for a further period of 12 months.
In terms of content, the warning must be provided in a durable medium and must warn the client in plain language that more than 25% of their non-workplace pension is invested in cash-like investments and the value of their non-workplace pension is at risk of being eroded by inflation. It must include a generic example of how inflation erosion would affect a £10,000 cash pot over 10 years, assuming 0% interest. It must also inform the retail client that they should consider whether their current investments are likely to grow sufficiently to meet their objectives.
The warning needs to come with a number of caveats. In summary, the firm is required to inform the client that it is a generic warning and not a substitute for professional advice and that the value of investments can fall as well as rise. It is also required to explain to and/or illustrate that different types of investment have a different balance of risk to potential gain.
Finally, it is required to include a statement to the effect that, where applicable, the firm makes available investments for inclusion in non-workplace pensions, including the default option. Default options are another matter covered in the same regulations and, in essence, require schemes to offer the member a personalised default investment option when the account is opened and again where an initial cash contribution is made.
Whilst the above is a concise summary of the key points of the new regulations, as with most FCA initiatives, the precise wording is significantly more complex. It sounds like a dead certainty for the next edition of the R04 study text.
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