Mutual Fund Lingo – A Primer on Fees

Chances are you own or have owned a mutual fund at some time. But do you know how much you are paying for your funds? Because you don’t usually see what fees you are paying on your statement, it’s easy to ignore the issue of fees. Turns out most other Canadians are doing the same thing.

According to Garth Rustand of Investor’s Aid Coop, Canadians are very passive when it comes to fees and we consistently pay the highest fees for mutual funds of any industrialized country – apparently we pay as much as 60% more than in the US and 200% more than in Europe – yikes!  Are we getting our money’s worth? Pretty hard to tell unless you understand some of the industry lingo and what goes into the mutual fund fee calculation.

Take “management fees” and “management expense ratios”. It’s a common mistake for investors to use the terms interchangeably, but they are definitely not the same.

Simply put, management fees represent the payment to fund managers for selecting the investments to include in the fund and are only one component of the overall fees you are charged.  The number that you should really be interested in is the management expense ratio or MER.

The MER includes the management fees plus other “indirect” costs such as: fund administration charges, legal, audit, custodian fees and transfer agent fees, advertising and marketing expenses and GST. It can also include sales commissions and ongoing trailer fees that are paid to your financial advisors for selling you the funds.

And just how much of a difference is there between the two charges? Let’s look at an example. Fidelity offers a Large Cap Canadian mutual fund with a management fee of 2.00%. After adding in all the other charges, the MER comes out at 2.47%.

So where does the MER show up in your fund? Because the MER is embedded in the published rate of return you don’t really see it, but it’s there if you look closer.  If the above mentioned mutual fund had an annual rate of return of 5.3%, this means that the investments actually yielded a return of 8% but then expenses of 2.47% were subtracted.

If you are comparison shopping this is the main number that you will need to compare – the rate of return after all expenses are deducted. MER information is published in the prospectus that you are given when you buy a mutual fund and can also be found on mutual fund info websites like globefund.com and morningstar.ca or by asking your advisor.

When comparing MERs from one fund to another make sure that you are comparing apples to apples. Typically management expenses ratios are highest for the specialty stock mutual funds and lowest for money market funds. Bond and balanced fund fall somewhere in the middle. Don’t try to compare the MER from one fund to another if the underlying investments are from different asset classes.

Because the MER can include commissions and trailer fees paid to the advisor channel, “load” funds typically have higher MERs than bank funds or “factory direct” mutual funds. Some of the better know mutual funds companies like Mackenzie, Fidelity, CI and Templeton are load funds offered through financial planners and investment advisors

“Factory direct” funds like those offered by Phillips Hager and North, Leith Wheeler, Mawer, or Steadyhand to name a few, often have lower MERs because they sell their funds directly to the investor through their own advisors.

Should you always go for the lowest MER funds? Of course it’s better to keep more in your pocket, but you also have to weigh out the value of advice. If your advisor is giving you great service and top notch financial planning and investment advice, then as long as you know what you’re paying for and see value, don’t fix what ain’t broke. If not, it might be time to explore some of the lower expense investment options. – Karin Mizgala

Karin Mizgala is a Vancouver-based fee-only financial planner with an MBA and a degree in psychology. She’s the President of LifeDesign Financial and co-founder of the Women’s Financial Learning Centre.

“Money Matters – But Less Than People Think”

On one otherwise unremarkable day, countless eons ago, one of our shrewder ancestors first exchanged puka shells, a red pebble, or a nugget of shiny metal for a wildebeest steak and human commerce was born. Or, more accurately, money was born. Ever since then people have been trying to link money and happiness. Are we happier with more money? Are we less happy with less money?

When asked if she is happy, Lara Aknin just laughs. Aknin is a doctoral student working with Dr. Michael Norton, Assistant Professor at Harvard Business School, and Dr. Elizabeth Dunn, Professor of Psychology at UBC. They are part of a growing body of researchers examining the links between money and happiness.

Lara speaks enthusiastically about her research and the conversation ranges from various psychological theories, to the recent economic crisis, to the country of Bhutan, the small Himalayan kingdom which measures its Gross National Happiness (GNH) along with its GDP.

“Money is only one factor that influences happiness,” Aknin says. “Work in the fields of Social and Positive Psychology, shows that personal relationships, religious beliefs, exercise, feelings of gratitude, random acts of kindness, as well as higher income, can all affect our sense of well being.”

Aknin is co-author of a recently published paper entitled “From wealth to well-being? Money matters, but less than people think,” that appears in the Journal of Positive Psychology.

According to their research, “a striking inconsistency surrounds the relationship between money and happiness.” It suggests that people “engage in behaviors designed to increase or maintain their wealth because they overestimate the impact that income has on well-being.”

People at different levels of income were asked to report on their own happiness and to predict the happiness of others. As one might expect, those surveyed accurately predicted the “moderate emotional benefits associated with being wealthy”. The big surprise was that they expected “low household income to be coupled with very low life satisfaction”, but that wasn’t necessarily the case.

As Aknin points out, this research might have important practical considerations for career choices, shorter work weeks or early retirement.

I frequently reassure my clients looking at a career transition or early retirement that a reduced income might not be nearly as bad as they fear. Now, thanks to Aknin and her colleagues, I have the research to back up my pep talks. As for finding an extra day for myself every week? That’s something that would make me very happy! – Karin Mizgala

Karin Mizgala is a Vancouver-based fee-only financial planner with an MBA and a degree in psychology. She’s the President of LifeDesign Financial and co-founder of the Women’s Financial Learning Centre.

Should You Borrow to Invest?

With interest rates at historic lows, a rising market, and money starting to flow again, some investment advisors are encouraging investors to look at the merits of leveraged investing.

Is this a good idea? Maybe, but first look at your reasons for why you want to borrow to invest. Are you hoping to make up the money you lost in the stock market over the past year? Do you feel like you’re just not getting ahead fast enough and want to implement what can sound like a “sophisticated” investment strategy? Or perhaps you’re facing increasing pressure from your investment advisor to put more money into a hot market.

There are conscientious advisors out there who can be of great assistance in advising you about the pluses and minuses of leveraged investing, but you should also take responsibility yourself to make sure this strategy fits with your goals, your psychology and your risk tolerance. Here are a few pointers to help guide you along the way:

Pluses of Leveraged Investing:

1. You can magnify portfolio returns;
2. You can deduct interest rates at your marginal tax rate. (Note, however that your investment must have the capability of producing income – not just capital gains. You might need to consult a tax expert.)
3. The cost of borrowing has never been lower. Some firms are offering an interest rate of prime + 1% on investment loans – or about 3.25%;
4. Dividend yields on many corporate stocks and bonds are outpacing interest rates;
5. Investors who are best suited to leveraged investing are generally those with no mortgage and low debt, a stable cash flow and a thorough understanding of the risks of leverage.

The Down Side:

1. While leverage can magnify gains, it can also greatly magnify losses;
2. Leverage adds a whole new level of risk to investing. You could be putting the collateral of your loan at risk, such as your house or mutual funds;
3. Buying “on margin” through your investment dealer typically means you can borrow up to 50% of your investment on margin. The danger is that if the markets drop, you are liable for a margin call requiring you to put money into your account to cover any shortfalls;
4. Remember, there is never a good time for a margin call. Just ask anyone who has experienced one in the last year what they now think of buying on margin.
5. Debts of any kind can dramatically increase your stress load. Paying off debts on investments that have just tanked is no fun;

Leveraged investing can be an attractive way to accumulate dividend-paying stocks and bonds if you have a long term investment horizon of ten years or more. Unfortunately many ill-equipped, ill-advised and ill-prepared people are also lured by the prospect of borrowing easy money to speculate in the market. Not only is that just plain bad business – it is also a recipe for disaster! Be careful out there. – Karin Mizgala

Karin Mizgala is a Vancouver-based fee-only financial planner with an MBA and a degree in psychology. She’s the President of LifeDesign Financial and co-founder of the Women’s Financial Learning Centre.

Mischievous Strangers & A Steadyhand

Economic depressions, recessions, downturns, slumps and hard times are nothing new. In his novel “Hard Times” written in 1854, Dickens comes down hard on the bankers and other financial experts of the day and rages against their dubious use of statistics to confound and befuddle the common man.

There is a rather poignant passage in Dickens’s rant against the economic power brokers of his day that bears some reflection during our own “hard times”:

“Now, you have always been a steady hand hitherto; but my opinion is, and so I tell you plainly, that you are turning into the wrong road. You have been listening to some mischievous stranger or other – they’re always about – and the best thing you can do is, to come out of that.”

Tom Bradley hardly claims to be a latter-day Charles Dickens. But as President of Steadyhand, a rather aptly named Canadian mutual fund company, he does write frequently on what he sees as the problem of relying on those “mischievous strangers” to do our financial thinking and investing for us. As Bradley puts it, “I am continually impressed by just how wrong economists and financial analysts can be.”

I personally like Bradley’s investment philosophy that relies on a straightforward lineup of no-load, low-fee mutual funds that Steadyhand offers directly to investors. He believes that most Canadians are over-diversified and overwhelmed with too many investment choices and too many flavors of the month. His firm offers 5 funds with concentrated portfolios largely unconstrained by geography and market cap size.

Steadyhand is also firmly committed to “transparency” when it comes to rates of return and fees. Their statements are simple, clear and easy to read – a rare and welcome occurrence in the industry.

Before launching Steadyhand, Bradley was President and CEO of the highly respected investment firm, Phillips, Hager & North. “I learned from the best, like Art Phillips and Bob Hager. They tried to keep it simple – and they were right!”

Despite his many years in the business, Bradley is still shocked by how few investors have an investment plan, even those with large portfolios. He insists that even a “back-of-the envelope” plan would provide a framework to help guide investors through a maze of often contradictory information, advice and, yes, statistics. “Even a simple spreadsheet can tell you a lot about a proper asset mix”, he insists. “Most people are way too diversified. Without a plan it is difficult to know what a good asset mix is.”

Bradley is committed to educating the public about the investment industry from an “insiders” perspective and isn’t afraid to express controversial views in his regular blog posts and Globe & Mail column. For an interesting read on how the company started out, check out The Steadyhand Diaries.

Steadyhand runs a series of info session across Canada where investors can “kick tires” and, as Bradley puts it, “learn how Steadyhand is changing investing in Canada.” Not sure that Canada needed yet another mutual fund company, but this one just might be on to something. – Karin Mizgala

Karin Mizgala is a Vancouver-based fee-only financial planner with an MBA and a degree in psychology. She’s the President of LifeDesign Financial and co-founder of the Women’s Financial Learning Centre.

Pensions – What, Me Worry?

We know there are serious problems with the pension system in Canada. It’s been increasingly difficult of late to ignore the news headlines that remind us that pension plans are underfunded or that many individuals are ill-prepared for retirement. This news understandably breeds anxiety amongst the baby boomer generation now approaching retirement age. Setting aside the more existential questions of how we went from Woodstock to “bonds ‘n stock”, we should be asking ourselves, whether or not this fear is justified. In short, should we be worried?

For most people, the biggest risk comes from not understanding what kind of pension you have and what this will mean to you in retirement. When it comes to retirement planning, we generally spend most of our time worrying about the uncontrollables – the world economy, market returns, and the survival of company or government pensions. Sure these are real concerns and you may have some impact on the outcome through information and advocacy, but there is a limited amount that any one person can do to change those bigger realities. Right now, it’s far more important for you to understand exactly what you need to retire securely.

Here’s what you need to ask yourself:

1.) What kind of pension do I have now and what will it realistically provide?

2.) What will my lifestyle needs be in retirement and will the pension and other investments be sufficient for my needs?

3.) Will I still need to continue making payments on mortgages or loans when I retire?

4.) What do I need to put in place now to become financial secure by retirement?

What kind of pension do you have?
1.) Defined Benefit Plan: 16% of private sector workers and 78% of public service workers have one of these plans where the employer makes the investment decisions and the employee gets a guaranteed pension amount based on income and years of service;

2.) Defined Contribution Plan: The employer, and sometimes employee, contributes to the plan, but the employee makes the investment decisions and the pension value at retirement depends on investment performance.

Until recently, it was assumed that the much coveted Defined Benefit Pensions were the “safe” ones” because the employee was guaranteed a fixed monthly payment at retirement. Now we learn that they are under scrutiny because of chronic underfunding.

The big question, if you have a defined benefit plan, is whether or not your employer will be able to meet it’s obligations to you throughout your retirement. The biggest risk is if the pension has a shortfall and the company goes bankrupt. If this happens you could lose part of your pension, but not likely all of it. Pension assets are held in trust, so a company can’t use it for its operations to keep afloat.  Operating companies who have a shortfall generally have time to make up the shortfall so you may never be affected.  These days some companies (like Air Canada) are negotiating longer time frames to make up the shortfall. Here’s hoping.

In my experience people worry most when they don’t have enough information and they feel out of control. Focus on what you can control – creating a plan, paying down debt, monitoring your spending, getting educated and informed. Nothing in life is 100% guaranteed so find out what’s happening with your pension, have a plan and expect the best — be prepared for the worse – then, let it go. – Karin Mizgala

Karin Mizgala is a Vancouver-based fee-only financial planner with an MBA and a degree in psychology. She’s the President of LifeDesign Financial and co-founder of the Women’s Financial Learning Centre.

Socially Responsible Money

Since we founded the Women’s Financial Learning Centre four years ago, Karin and I find oursevles asking the same question over and over again -

Why is it so hard to encourage women to take charge of their finances?

We’ve heard all the usual reasons – lack of time, lack of interest, lack of money, fear, guilt, prince charming syndrome but it really gave us pause to think when a recent workshop participant said that she avoided dealing with money because she didn’t like the context that money plays itself out in.  She didn’t want to engage in a world of corruption, greed, materialism, so she simply withdrew and ignored thinking about, talking about and dealing with her finances.  Needless to say the “dig your head in the sand” approach didn’t work very well for her and she ended up in financial trouble.

But she did say something very important that we know many women are feeling – a sense that something is wrong in the financial and economic world, but feeling powerless to do anything about it.

After all – where would we even start? Everyday there’s yet another story of how companies or advisors have abused our trust, how governments are bailing out irresponsible corporate behavior, how we’re sacrificing our environment for the sake of economic growth and development, how children live in poverty around the world while others spend millions on rocket ship rides to outer space for fun.

Clearly there is something wrong with the way that we distribute and allocate economic resources in our world – so no wonder we aren’t keen to get involved and perpetuate the problem.  Not to mention how busy we all are.

How can we take on one more thing?
The short answer – we need to.  We need to for our sake, for our family’s sake and for the sake of our communities.  Many world leaders and thinkers including the Dalai Lama and Stephen Lewis are saying that it’s up to women to change the world. No pressure though!

It’s up to Women to Change the World
And we can – one woman at a time, taking one small step at a time.  By 2019, women will control over 70% of the wealth in North America and in a world where money talks, we’ll be able to speak loudly!

All it will take is for each of us to become a little more conscious, educated and engaged in how we make, manage and invest our money to make a significant difference in how money is handled in our world.

The first step is to understand the world of money as it exists now and then to make choices that will help perpetuate change  – one smart choice at a time.

Let’s start talking about money and the changes we’d like to see.  Join us on Thursday November 19th for an evening of discussion and idea sharing on the topic Socially Responsible Money – How to Make, Manage and Invest Your Money to Create a Better World

Click here for more details

How about our troubled workshop participant?  She now has her finances in order, a career path that is consistent with her values, and a desire to earn lots of money – on her own terms.

The Goldilocks Guide to Life Insurance

Not too hot – not too cold – but just right!  Unlike in the Goldilocks fairytale, most people don’t get it “just right” when it comes to insurance. Most of us are either under-insured or over-insured. Yes, over-insured!

So, let’s start with how much life insurance your family truly needs. If either you or your spouse dies, would the survivor(s) have sufficient means to:

• Pay off debts
• Maintain their lifestyle and continue to save for the future;
• Pay added expenses, such as funeral arrangement, legal or estate tax bills.

If your family has the financial capacity to cover the above (make sure you go through the exercise for each spouse), then you likely don’t need insurance at all. If you don’t, then you’ll need to buy life insurance.

Your insurance needs are generally highest when you are just starting out with your career and family. Typically insurance needs gradually taper off as debt is paid down and assets are accumulated.

(While there are some specific reasons for holding life insurance throughout your entire lifetime (eg. business succession, transferring cottage assets to family members, dependents with special needs), these insurance needs are less common, more specialized and will definitely require individualized professional advice.)

Too little insurance:
Typically younger people don’t have enough insurance, and often it is the wrong kind.  Usually we need a lot more insurance at the beginning of our careers, when children are young and especially if one parent stays at home. Term insurance generally works best here – it’s cheap and exactly suited to this type of need. However, with little understanding of insurance and the ever increasing complexity of insurance options, many younger people are talked into universal life policies that don’t match the reality of their lifelong needs. These insurance policies are also touted as savings vehicles, but as far as I’m concerned, they are unnecessary, expensive and too complicated for the average family.

Too much insurance:
What I’m seeing lately are many people in their 50’s or 60’s who put their insurance plans into place early on, but haven’t recently updated them. Since their last insurance review, their debts are much lower or paid off entirely, savings and investments have increased and, with kids now out on their own, household expenses are substantially lower. With these life changes, there may be little or no need for continuing to pay insurance premiums.

So, if the kids are relatively self-sufficient, if one income is now enough to live on, or if you have accumulated enough assets, then it’s time to revisit your insurance policies.  Remember that term insurance premiums increase with age, so you may be getting the double whammy of paying more for coverage you don’t actually need anymore. I just went through this analysis with some clients and it saved them over $4,000 a year!

Just the right amount:
Take a few minutes to review your insurance coverage. Be realistic about your current circumstances and needs and your future requirements. (And don’t be pressured by those darned “bears” into paying for more insurance than you really need.) Determine exactly what the correct balance is for you and your family at this specific stage of your life. After all, it needs to be “just right”! – Karin Mizgala

Karin Mizgala is a Vancouver-based fee-only financial planner with an MBA and a degree in psychology. She’s the President of LifeDesign Financial and co-founder of the Women’s Financial Learning Centre.

What Would Mahatma Gandhi Invest In?

If the great Mahatma was around today, I wonder if he would be scouring the TSX or the Indian Stock Exchange to check on his portfolio of socially responsible investments (SRIs)? Well, ok, I admit that the idea of Gandhi, or Mother Teresa, dabbling in the rough and tumble stock market seems just a little farfetched – if not a tad unseemly. But, nevertheless, there is worldwide movement afoot dedicated to ethical investing — where principles are as important as profits.

While SRI funds are themselves a relatively new investment phenomena, the idea and moral force behind them certainly is not. As far back as the 1750s abolitionists, such as the Quakers, put pressure on companies and individual investors to try and halt the slave trade. In the 1950s and 60s other groups, such as trade unions and Vietnam War protestors, tried to advance their social and political agendas by influencing where people spent and invested their money.

Socially responsible investing is big business now, with some researchers forecasting the SRI market in the US alone to reach $3 trillion by 2011. And the Americans are not alone in their appetite for this type of investment. In Europe, the SRI market reportedly grew from an estimated €1 trillion in 2005 to €1.6 trillion in 2007.

And Canada is following suit. Almost 20% of investments in this country now fall under the SRI umbrella – totaling some $609 billion in 2008.  In a sign that SRIs are here to stay, loyal Canadian investors are sticking with this class of investments despite the recession and recent market woes. In fact, according to some financial experts, the value of SRI assets in Canada has actually grown by 21 per cent over the past two years.

How to get a Good Return?
The big question for investors, however is how to get a good ROI, or return on investment, while still doing the right thing with their money. The answer comes down to five simple considerations:

1. Recognize and acknowledge that your individual investing decisions have far-reaching consequences not only for yourself but for society as a whole;
2. Ask yourself what industries or sectors you want to support (alternative energy companies, organic food producers) — or not support (alcohol, tobacco, gambling, weapons manufacturers);
3. Educate yourself about the specific companies and investment funds that support your social objectives and ideals;
4. Find a supportive investment advisor – one who will not only help you select companies or funds that meet your SRI guidelines – but that also fit in with your overall investment strategies and financial plan;
5. As always, check on the track record of the investments you are considering – and make sure you will be getting value for the fees being charged.

Here are some resources you may want to check out: the SRI Monitor, Social Investment Organization, Jantzi Research.

There’s certainly debate on the concept of SRIs and whether they are really a sound investment or just a marketing ploy.  SRIs may not be perfect, but they are an important reminder that all of our financial decisions have an impact on the world around us – one investment at a time.

Karin Mizgala is a Vancouver-based fee-only financial planner with an MBA and a degree in psychology. She’s the President of LifeDesign Financial and co-founder of the Women’s Financial Learning Centre.

Good News for Do It Yourself Investors

If nothing else, the financial turmoil over the past year or so has caused many investors to revisit their portfolios and rethink their investment strategies. Along the way, some have started to ask if they were getting good value from their investment advisors — or if they were better off going it alone.

Here is some good news, if you:
1.) Know, or at least suspect, that you are not getting the service and professional advice you need from your advisor
2.) You are considering switching advisors
3.) You want to continue using an advisor, but also want to become more informed and directly involved in your investment decisions
4.) You just want to go it alone — but could use some help.

Check out the Investors-Aid Co-op. It was formed in May 2008 by Garth Rustand, who now serves as Executive Director, along with a seasoned team of professional advisors. As they bill themselves: “Canada’s first co-operative for investors is run by members for members. It is the new way to invest.”

Garth was in the brokerage biz himself for 20 years so he knows “the other side”. He felt that “there wasn’t anything out there that provided truly objective information to help investors lower their costs of investing, and to protect them from products and services that just aren’t very good.”

The Co-op itself has got to be one of the greatest investments out there. A “lifetime” membership fee is just $35. For $30 more you can get two very helpful books to guide your investment strategies – whether you want to continue using an advisor or are ready to go strictly on your own.

I joined the Co-op myself and was especially impressed with the level of detail in their guidebooks. They outline specific portfolios and investments that were picked for quality and low fees. Another plus, is that the language is down to earth and very easy to read for the average investor. The sample portfolios feature lots of exchange-traded fund, (ETFs), but not exclusively. This is very helpful info if you’ve been considering ETFs or low-cost mutual funds but need some guidance and direction.

The Co-op also provides good consumer reports and other valuable investment information. Another membership plus is that you can email the Co-Op with your specific investment questions. And, for an additional charge, they can also provide you with an independent portfolio review. (In my opinion, the Co-op has way underpriced this valuable service!)

What I like most about the Co-Op is that it is educational in nature. They aren’t trying to “sell” you anything, other than straight-forward investor education and consumer info. They truly seem to have the investor’s best interest at heart.  Knowing how much money can be made as an investment advisor – and what Garth likely gave up financially to help out the rest of us – he sure isn’t motivated by the money anymore! – Karin Mizgala

You can learn more about the Investors-Aid Co-op at: www.investors-aid.coop

Or click here for an audio replay of a recent Women’s Financial Learning Centre Teleclass “How to Get the Best Deal on Your Investments” with guest speaker Garth Rustand.

Karin Mizgala is a Vancouver-based fee-only financial planner with an MBA and a degree in psychology. She’s the President of LifeDesign Financial and co-founder of the Women’s Financial Learning Centre.

How Much Cash Should you Hold?

Risk averse Canadians are sitting on an “astoundingly massive” $1 trillion or more in cash, or near cash holdings, according to a recent study by Scotia Capital Inc. While we might pride ourselves on being prudent savers, some experts are warning that our rainy day funds are now so large that they could jeopardize the country’s economic recovery. They also fear that you are not getting a good return on cash holdings. So what is right for you?

It is certainly true that cash investments aren’t very exciting these days. Rates of return for so called “high” interest savings accounts run at around 1.5% or less, and 5 year GICs are only returning 3%. And of course, over the long run, cash investments haven’t done as well as bonds or stock investments. But still, I like cash – a lot.

There’s much more to investment planning than just getting the best rate of return. Sure inflation is an important consideration. So, too, is outliving our money. So is having enough money to meet future expenses and goals. BUT – if our investments are ultimately designed to help us enjoy our life, then we need to consider the emotional as well as “dollars and cents” implications of financial security. Being stressed about money doesn’t make for good investment decisions or a happy life.

As a financial educator, I know firsthand the value to clients of being more educated about how money and investments work – greater understanding of money usually leads to better financial decisions and less worry. But I also know that graphs, charts, and financial calculations can only go so far to relieve the anxiety caused by market fluctuations.

So what do these concerns mean to your portfolio?

Let’s start with a simple and obvious fact. We’re human. Sometimes we make irrational decisions based on emotions – sometimes fear, sometimes greed, sometimes wishful thinking. Even though we “know” we should keep our emotions from dictating our investment decisions, it is unlikely that our species is going to change this type of instinctual behavior anytime soon.

So you need to make investment decisions that suit all of your needs — including the very human need and desire for security. This means that cash investments should always be an integral part of your portfolio. The amount of cash you should hold is largely dependent on two factors. First is your tolerance for risk. Second are your cash needs for the near future.

So for instance, if you don’t want to take any market risk at all, then your choices are pretty much limited to a 100% cash or government bond portfolio. (If you take this strategy, you should run the precise numbers to be sure that you’ll have enough to cover your long term needs after tax and after inflation.)

And even if you can accept a high level of risk in your overall portfolio, but need to use some of your funds in the next 2-3 years, your best bet is to hold the total amount you will need in cash or near-cash investments.

How does this work?

Let’s say you want to buy a house in 2 years but first have to save for the down payment. Your existing savings and new money should be held in cash investments so you can be sure that the money is there when you need it – regardless of what happens in the markets.

Or if you’re at retirement age and you need $3,000 a month ($36,000 annually) to fund your lifestyle, then keep a reserve of about $100,000 in cash to fund the next three years. This will give you the emotional upside of knowing that you have cash in the bank and you will be financially ok for the next few years.

By holding cash for your 2-3 year short term needs, you will be more comfortable with your other higher risk investments that you need for growth. Then even when the markets fluctuate wildly, it will be easier for you to resist the temptation to react emotionally because you know that some of your portfolio is protected. Not an exciting strategy but a good night’s sleep sure make sense to me.  – Karin Mizgala

Karin Mizgala is a Vancouver-based fee-only financial planner with an MBA and a degree in psychology. She’s the President of LifeDesign Financial and co-founder of the Women’s Financial Learning Centre.