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Inflation-beating cash accounts deserve a share of your portfolio

The focus on maximizing investment returns is pervasive. Instead, why not focus on the return required for achieving your investment objective of building a retirement fund of a certain size?

If an investor has a good savings regime in place, annual returns of 2 to 3 per cent might suffice for generating the amount of capital they need to retire on. There is no need to take on the extra risk of chasing higher returns. Let others ride the emotional roller coaster that comes with a high exposure to the stock market (all the more so now that stocks have had a multi-year run-up in price).

Perhaps the quest for maximum returns reflects, in part, the workings of the financial industry. "Most investment advisers are programmed to shoot for the highest return possible while staying within the level of risk their clients can tolerate," notes Warren MacKenzie, founder of Weigh House Investment Services. "It is not uncommon for investors to be in portfolios that have higher risk than necessary."

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Moreover, the questionnaires used to assess risk tolerances do not always provide an accurate picture. Investors' taste for risk tends to vary over the course of bear and bull markets, so if responses are provided when bullishness reigns, advisers may be maximizing returns to overstated risk preferences.

A commonly suggested asset allocation is 60 per cent in stocks and 40 per cent in income-bearing securities. But for some investors, it might be more appropriate to have a portfolio composed of (say) 33-per-cent stocks, 33-per-cent income securities and 33-per-cent cash.

Cash is usually dismissed as an asset that yields negative returns after inflation and taxes. But some high-interest savings accounts (insured by the Canada Deposit Insurance Corporation) now pay between 2 to 3 per cent (see Peoples Trust, Canadian Direct Financial, etc.), well above the current inflation rate of 1 per cent. They thus deliver virtually risk-free real rates of return between 1 and 2 per cent; if held inside a Tax Free Savings Account, those returns are tax free.

Rates paid on these accounts will also rise if market yields and inflation rise – without triggering capital losses as bond exchange-traded funds and longer term bonds could do. When rebalancing portfolios, investors should perhaps give some thought to moving their savings into cash, away from richly valued stocks and bonds – especially if investors' investment objectives don't demand high rates of return.

Jason Zweig, a leading personal-finance columnist in the U.S., once asked a group of retirees in a luxury retirement community if their investments had beaten the market over their lifetime. Some said yes, some said no. One said: "Who cares? All I know is that my investments were good enough to get me here." That seemed like the perfect answer to Mr. Zweig.

Larry MacDonald is a retired economist who manages his own portfolio and writes on investing topics. He tweets at @Larry_MacDonald

READERS: Would you consider upping your porfolio's share of cash with a high-interest account?

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