In 2008, many people discovered the benefits of not having their entire retirement in the stock market. Markets had risen for several years! Everyone was predicting that the golden days would continue! Then, things changed - rapidly! Retirement portfolios dropped in value by 35 to 40% within a few months!
People who had been planning to retire early suddenly found themselves wondering if they would be able to retire at all!
Those who had the courage to ride out the market cycle had recovered most of their money within 2 years. Some people who planned to retire soon needed to get at their money within a year or so. Many of those people panicked! They sold their portfolio at the bottom of the market!
How to prevent this from happening to me?
Sadly, you can't control the stock market, which will continue to go through boom and bust cycles. Those who understand and control market psychology use these cycles to take money from those who DO understand! If you don't know how this happens, see our article on
Stock Market Basics.
The secret to growing your wealth is not preventing the market from collapsing, accurately predicting the downturns or keeping your money out of the market entirely. That could cut your monthly cashflow from your investments by 40% or more! Instead, the secret is to build your investment portfolio to ride out these inevitable downturns! Separate the cashflow you'll need over the next two years from the market!
That's the purpose of the near-term account in your overall portfolio.
How can you keep this monthly cashflow secure? Let's look at your options.
Offerings from Your Bank
Those who have read many articles on this site already know that I don't recommend investing at your bank branch. However, the banks and credit unions are excellent sources for short-term, guaranteed investments.
In our article
What is Risk, we show why informed investors don't lock away their long term nest egg in guaranteed investments! They know that these investments lose purchasing power over the years! These are short-term investments, not any part of your long-term plan! The short-term risk of losing money in the market makes losing a bit of purchasing power a reasonable step to take!
In the overall business model of the banks, the branches represent low-cost sources of capital. My mentor in the financial industry used to say "Banks are great places to get money, but not good places to put money, if you want it to grow!" So what are the best options at your branch?
Guaranteed Investment Certificates (GICs)
These are contracted deposits at the bank, with a fixed number of years, varying from 1 to 5 years. Money deposited is locked-in for that time period. The branch people will tell you that you cannot get your money back until the certificate matures (when the contracted time has expired). However, branch management has the authority to end the contract immediately, and refund your money. The penalty is any interest payments the GIC has accumulated. The short-term account is used for money to be used within 2 years. Only half the money can be put into a one year GIC as the other half will be distributed monthly during this year. For example, if you need $1000 a month from your investments, then there should be $24,000 in the short-term account. $12,000 of this could be used to purchase a 1 year GIC. The timing makes sure that this money is available for monthly cashflow in the second year.
91-, 182-, and 271-day notes
These are similar to GICs, but have terms of 3, 6, or 9 months. The returns are close to money market rates - typically higher than GICs. Usually there is a minimum deposit requirement which might prevent the use of this option. As with GICs, take care not to lock away too much money for an excessive amount of time.
High Interest Savings Account
Chequing accounts do not earn much, if any interest. To address customer concerns about the low rates on deposits, the banks created a higher interest savings account. These pay rates lower than GICs, but higher than the basic account. This account can be used for money that will be withdrawn in the next 2-3 months. The account is especially useful if there is not enough money to purchase the notes mentioned above.
Non-Bank Options
Many people use an independent advisor for the mid-term and long-term accounts. For these people, another option is to keep the short term account in money market mutual funds. These usually provide a higher return than the bank's equivalent notes. To get the money into your chequing account monthly, set up a Systematic Withdrawal Plan (SWP). The SWP transfers a set amount of money on a specified day every month. If that day falls on a holiday or weekend, the money is send on the next working weekday.
This is the recommended option for my clients. It separates the operational chequing account and the short-term account which helps to fund it. This setup encourages discipline in maintaining a monthly budget.
Every plan is subject to unplanned events. Your 3-Plan lifestyle is no exception. For any major unplanned expenses that arise, take the money you'll need to cover the expense from the long-term fund.
To review the overall 3-Plan Strategy, go
here.
