I love those ING Direct commercials where the Dutch guy always says “save your money.” So I thought I’d examine how good ‘saving your money’ really was.

September has been a rough month so far for investors. Heck, the last few months have been rough for investors. The markets are extremely volatile right now and have been on a downward trend since June. One day your portfolio could be in the green, the next day it could very easily be in the red, and back and forth. So what’s an investor to do?

Investors looking to escape the turmoil of the markets are turning to cash as a safe alternative. At first glance, money market funds may seem like a good idea, but you must consider all factors – namely taxes and inflation.

Let’s say you buy a $1000 GIC (which is virtually risk-free) with an annual rate of 3.5%. So in a year you’ll have 1000 + 35 = $1035. Now the first to take a piece of that pie is the taxman. In Canada, interest income is fully taxable at your marginal tax rate. Let’s say your marginal tax rate is 40%. That leaves you with $1021, or an after-tax return of 2.1%. Now economics comes into play. Investors are more focused on real return or purchasing power. In other words, your return after the effects of inflation. So far this year, inflation has averaged about 2.3%. Now your real return actually turns out to be 2.1 – 2.3 = -0.2%. So your original investment of $1000 is really only worth $998 when you take into account taxes and inflation.

The rates I’ve used are always changing and your marginal tax rate will depend on your personal income, so don’t take my example as concrete. But the point I want to make is that you must fully educate yourself on all factors when making any investment decision.