Going to cash when the market tumbles can crush your retirement

’s 2:30 in the afternoon and I’m on the phone with a client who’s uncomfortable about the market declines we’ve been experiencing. The temperature in my office seems to be rising by a degree a minute. It’s getting hot in here, even though it’s -24 degrees outside.

In the pit of my stomach I can sense they are going to ask to do the one thing I’ve been coaching them not to do since they became clients. “MOVE MY MONEY TO CASH!” they blurted out.

Ugh!

My stomach sinks, because I know this is the exact wrong thing to do at this moment in time.

It’s already too late

By now most global equity markets are down from their previous highs reached earlier in the year. So much selling has already occurred. It’s too late to make the decision that really would’ve protected their capital in the short run, and now their tactic is all about stopping the anxious feelings that would come from further declines. Right now, any decision is an emotional one. Remember, emotions don’t create affluence.

Investor psychology will rear its ugly head

The narrative you’ll tell yourself in this scenario (markets are down, so I should sell out) is often the same. You’ll tell yourself that you’ll get out of the market now while everything is chaotic, and you’ll get back in when the market is on more even footing. However, psychology being what it is, you likely won’t get back in until the market is materially higher from where you sold out. Why? Because you need confirmation that the market is headed higher. But that line of thinking turns the best approach to investing “buy low, sell high” on its head. Basically you are now selling low, and buying high.

Inflation erodes your purchasing power

Not only is there a psychological tendency to sell low, and buy higher, inflation will erode your purchasing power while you sit in cash. Right now the five year rate that you’ll receive on a GIC is 2.5%. Inflation is running 2% according to the bank of Canada, meaning that you are becoming wealthier by 0.5% a year pre-tax.

At those rates, it would take your money about 139 years to double in value. 139 years is two lifetimes. If you want to make sure that your money grows for you throughout your retirement so that you can live the lifestyle you want, and also have the option of leaving some money behind, a 0.5% real return on your money isn’t going to cut it.

The more likely scenario is that you’ll run out of money. How do I know this? Here’s an exercise - Take your current pool of capital, divide it by the annual income you need to meet your lifestyle expenses, and voila, you have the number of years your capital will last (it’s likely a lot less than how long you’re actuarially expected to live).

Taxes destroy what’s left of your return

Lastly, income earned from GICs and savings accounts held in taxable accounts are taxed at your marginal rate. Meaning, if you are a high income earning Canadian (someone earning over $100,000 a year in employment income), then your interest income will be taxed at 40% or more if you live in Ontario.

If you earn 2.5% on your GIC, you’ll give 2% away in inflation, and 1% away in taxes. Leaving you with a negative real return. That’s not a way to get rich, and in reality is a path to wealth destruction.

What if you own your GICs in your RRSPs?

You won’t pay the 1% tax immediately, however, any money you withdraw from your RRSP is taxable as ordinary income. Let’s say that you have $400,000 in your RRSP, and you are 62 years old. You plan on retiring next year, and want to live on $35,000 net of taxes. That means you’ll withdraw $41,000 a year from your investments. You can do that for 11.32 years before all your money is gone. It’s not the ideal retirement investment or income plan.

A long-term focus is required

I’ve laid out that going to cash or GICs in a market selloff will destroy a long-term retirement plan. But what’s the alternative? The alternative is coming up with a long-term plan and sticking with it through thick and thin. Don’t change course midway through your trip because the weather got bad for a while. When you go on a long road trip, you can’t reasonably expect smooth sailing the whole time. The key is to keep moving towards your destination.

If you are interested in putting together a time-tested investment program that’s designed to last you through your retirement, reach out to me today by email at kurt.lucier@raymondjames.ca with a brief description of your current circumstances. I’ll get back to you within 48 business hours to set up a quick 15-20 minute introductory discussion to learn more about you and your long-term plans.

Happy planning,

Kurt Lucier, CFA

Information in this article is from sources believed to be reliable. However, we cannot represent that it is accurate or complete. It is provided as a general source of information and should not be considered personal investment advice or solicitation to buy or sell securities. The views are those of the author, Kurt Lucier, and not necessarily those of Raymond James Ltd. Investors considering any investment should consult with their investment advisor to ensure that it is suitable for the investor’s circumstances and risk tolerance before making any investment decision. Raymond James Ltd. is a Member Canadian Investor Protection Fund.