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A year ago, the idea of retirees keeping two or three years’ worth of expenses in cash seemed like the biggest waste of time ever.

Stocks were soaring, and interest rates on high interest accounts and guaranteed investment certificates you could integrate into your investment account were in the range of 1 to 2 per cent. It seemed almost negligent to forgo double-digit stock market returns in favour of interest paid at a rate that barely kept pace with inflation.

But after the stock market plunge that began in late February, it’s now clear that maintaining a cash cushion should be Rule No. 1 in building a retirement portfolio. First, establish the cushion. Then divide money between stocks and bonds.

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The benefit of holding a few years’ worth of cash is that you have resources to draw on if the stock markets crash. There’s no need to cash in your beat-up stocks or equity funds, and neither do you have to deplete better performing bonds and bond funds. The cash can be held in high interest savings account mutual funds or exchange-traded funds within an investment account, or in a high interest bank account held outside the portfolio. Another option is a three-year ladder of guaranteed investment certificates. In all cases, make sure you stay within the deposit insurance limits imposed by Canada Deposit Insurance Corp. or provincial credit union insurance plans.

I have heard from several readers in the past couple of weeks who would be feeling somewhat better about things if they had a cash cushion. They’re stressed about having to sell stocks and equity funds that have been slashed in price to cover their annual required withdrawals from a registered retirement income fund, or just to meet living expenses.

People who are looking just ahead to retirement should consider the cash cushion as well. In fact, a cushion makes sense even five years away from retirement. Retirement ideally takes stress out of your life. You don’t want to exit the work force into a world where falling stock markets are hacking away at the portfolio you will imminently be drawing upon.

The math of investing is cruel after a big decline in the stock market. A $100,000 investment that falls by 30 per cent to $70,000 requires a 43-per-cent gain to get back to even. That’s a massive turnaround, but possible over a period of years. With a cash cushion, you can wait for that recovery.

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