Just a generation ago, investors could use Guaranteed Investment Certificates (GICs) to meet long-term financial objectives. In 1990, five-year GICs were paying upwards of 10% annual interest.¹ Incorporating GICs, money market funds and treasury bills into an investment strategy was often an appropriate and easy decision.
It’s a different story today. With low interest rates, it takes more thought and planning to determine when it’s helpful to choose cash equivalents and when it’s unwise.
So when should you stick with cash equivalents? Basically, when you want to be able to access your money quickly and you can’t afford to risk losing any capital, even temporarily. Here are four typical situations when safety makes sense.
Emergency funds. When you set aside funds for emergencies, you want to be certain the money is there when you need it.
Maturing goals. A Registered Education Savings Plan (RESP), likely growth-oriented at the outset, will look a lot different as post-secondary graduation gets close. You want to be able to withdraw the funds when you need to pay for education-related costs.
The strategy’s the same for retirement savings. Several years before you retire – and during retirement – you want at least some amount of your nest egg to be protected against market volatility.
Short-term objectives. When you’re saving for a near-term goal, like a vacation, it’s the setting aside of funds that matters most, not the returns.
Windfalls. A money market fund or other cash equivalent is typically the parking spot for an inheritance or other windfall, while you plan how to invest for the long term.
Sometimes investors move to safety for the wrong reasons – generally one of the following.
Market timing. When markets are in a prolonged downturn, some investors are tempted to put their periodic contributions into money markets instead of their regular investments. But staying out of the market often means missing out on the recovery and buying back in when prices are higher.
Choosing no risk over low risk. A very conservative investor with a long-term objective that doesn’t require high returns may believe low-interest vehicles are the solution. Trouble is, cash equivalents may barely keep pace with inflation. Other choices may better meet the objective while still suiting a conservative profile, including fixed-income investments and dividend-paying equities.
Putting tax considerations first. There’s a rule of thumb about holding favourably taxed equities in non-registered accounts and more heavily taxed fixed-income investments in tax-deferred and tax-free registered plans. Unfortunately, this leads some investors to over-invest in GICs, money market funds and other fixed-income investments within their Registered Retirement Savings Plans (RRSPs) and Tax- Free Savings Accounts (TFSAs). Investment objective, not tax-efficiency, should guide investment decisions.
Situations arise when the choice isn’t so obvious between investing with safety in mind and investing for long-term growth. Talk to us whenever you need help making the right call.
¹ Source: Bank of Canada, Selected Historical Interest Rates.