S&P/TSX composite index 3-month chart

Canadian investors have rushed to the safety of cash as they try to ride out current market volatility — a strategy that could cost them billions in potential gains, an economist warns.

Canadians are sitting on a record $45 billion in excess safe, liquid assets that would normally be invested in the market, according to a report Wednesday by CIBC World Markets economist Benjamin Tal.

"If history is a guide, investors who are sitting on the sidelines to wait out the volatility will hang on to the cash too long and miss out on billions of dollars in lost investment opportunities," he said.

Tal's estimate of $45 billion in extra cash is based on his analysis of the amount that would have normally been invested in the markets given the risk level that was apparent just as the current financial crisis was starting.

Since then, all indicators show that Canadians' holdings of cash and cash equivalents have been rising rapidly, Tal notes.

Investors have been shovelling record amounts into low-risk money market mutual funds, with sales of $10.7 billion in the first three months of the year. Redemptions of higher-risk equity funds have reached $35 billion in the last six months.

Balances in chequing and savings accounts are up seven per cent year-over-year, while cash balances in brokerage accounts are up 15 per cent, Tal estimates.

Risk aversion rises with age

Older Canadians are leading the rush to cash. An Ipsos Reid-Canadian Financial Monitor survey suggests that the median cash balance held in chequing and savings accounts is now $7,650 for those 55 and over.

But current cash positions among the 25-to-49 set are still twice what they were in 2001. "Back then, some of the money that left the stock market was deployed in the real estate market," Tal said. "Today, this option is less attractive."

Market volatility has created a rush to cash before, and Canadians paid the price for sitting in cash for too long, Tal says.

After the 1987 market crash, overall cash positions held by Canadians grew 20 per cent. The market correction lasted two months, but investors sat on their "mountain of cash" for 16 months. In that time, the stock market gained 20 per cent.

Something similar happened following the 2001 correction, he says. "We estimate that by not adjusting their liquidity positions to pre-2001 levels, Canadians assumed more than $30 billion in lost investment opportunities."

Fast forward to 2008. Even though the Toronto stock market has risen 20 per cent from its January lows, Tal says Canadians are still sitting on 15 per cent more cash than they were in 2001. "By doing so, Canadians are sacrificing billions of dollars in potential investment gains."

Tal's employer, CIBC World Markets, sees the TSX rising further on the strength of higher energy prices and, eventually, a rebounding U.S. economy. Chief economist Jeff Rubin forecasts the S&P/TSX composite index will end 2009 at 16,200 — almost 1,800 points above its current level.