Holding cash is never a popular idea with clients because the return is low, especially considering the current low interest rates. But if your clients don’t have enough cash in their portfolio to meet their withdrawal needs, they may have to sell securities at a loss. Older clients are particularly vulnerable because they are at or near the end of asset accumulation. They also have to guard against the risk of substantial medical costs if their health deteriorates.
“None of my clients had to sell after the 2008-09 financial crisis,” says Janine Purves, senior financial advisor with Assante Capital Management Ltd. in Richmond Hill, Ont., “because they had enough cash for two to three years of potential withdrawal needs. Clients need a big enough buffer to live through market corrections.” She normally advises that “5%-10% of a portfolio be in more liquid or, at least, guaranteed investments.”
Other advisors, such as Barbara Garbens, president of B L Garbens Associates Inc. in Toronto and Adrian Mastracci, president and discretionary portfolio manager with KCM Wealth Management Inc. in Vancouver, also recommend that two to three years of potential withdrawals be held in cash or liquid investments.
“Generally speaking,” Garbens says, “I suggest setting aside three years of cash requirements in fairly liquid investments.” She acknowledges, however, that if clients have enough to live on from dividends, interest, pension income, and Canada Pension Plan and old-age security benefits, “they may not have to worry as much.”
Mastracci also recommends that clients have cash or cash-like investments to enable the clients to buy more stocks if their prices drop to bargain levels. He suggests a target of holding 5%-20% of a portfolio in very liquid forms. That is, 5% to cover possible withdrawal needs and the other 15% to be available for buying good securities at attractive prices. He notes that retirees need to pick up bargains because with increased longevity, these clients need to continue growing their assets.
However, not everyone agrees that this much liquidity is necessary – or even wise. Kelly Trihey, portfolio manager with Trihey Financial Group Inc., which partners with Industrial Alliance Securities Inc. in Montreal, thinks cash should comprise more than 3%-5% of a portfolio. And, she says, cash should be used solely to meet withdrawal needs so that clients don’t have to sell securities at a loss should they need the money within the next 12 months. She notes that although down stock markets can last as long as 20 months, bond prices usually rise when equities prices are low. Thus, a client can always sell a bond if need be.
Trihey disagrees with Mastracci’s approach; she says that trying to time the market seldom works. She advocates being as fully invested as possible at all times in a broadly diversified portfolio. When markets improve, she says, they usually do so very quickly, and if clients aren’t fully invested, they don’t participate in that gain.
Tony Salgado, director of tax and estate planning with Winnipeg-based Investors Group Inc. in Mississauga, Ont., agrees that most retail clients don’t need a lot of liquidity in their portfolios. As long as withdrawals won’t be needed to pay for regular expenses, he suggests three to six months of the client’s regular expenses be held in liquid investments, which should cover the cost of things such as a $5,000-$10,000 roof repair.
All these figures are targets. Liquid investments are built up to these levels when markets are strong by taking profits when valuations get high. The liquid assets then are liquidated when markets are down, withdrawals are needed and it’s not a good time to sell other holdings in the portfolio.
The investments in this liquid portion of a portfolio don’t have to be all cash or near-cash. Garbens and Purves both say that the amount needed to cover potential needs in the coming year should be in assets invested in money market funds or one-month treasury bills. The rest can be held in laddered guaranteed investment certificates (GICs) or laddered bonds. That means some interest is received, and losses for these holdings are minimized in real (after inflation) terms. The idea is that the liquid portion of the portfolio keeps turning over, maintaining the targeted near-term cash component but buying new treasuries, GICs or bonds to replace those assets targeted for needs further out.
However, Mastracci likes to see most of this liquidity, even if it’s 20% of a portfolio, in available cash or cash-like securities.
Trihey also favours very short-term investments in this portion of a portfolio, which is not surprising, given that her clients are aiming to cover only one year of potential withdrawals.
These strategies assume that a client doesn’t need to withdraw significant sums from the portfolio to cover essentials. These advisors all say clients with tight cash-flow needs should consider an annuity or guaranteed minimum withdrawal benefit product to cover essential expenses.
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