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December 2018

Improving Your Investing Behaviour

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Has volatility in the marketplace got you down? Here are some worthwhile considerations on how to improve one’s investing behaviour:

Remember your time horizon. Staying invested and sticking to a well-thought-out plan is the key to longer term investing success. This means avoiding the temptation to engage in market timing. Nobody has ever been able to consistently predict what the markets will do next. Volatility is inevitable in the short term, but, as history has shown, its effects smooth out over time.

Pay less attention to the financial headlines. It is easy to become preoccupied with the daily financial headlines. In the worst of times, the media can sensationalize the doom and gloom, which may feed speculation and cause poor decision making. Conversely, the media may create unfounded hype. Informed decision making should not be based on isolated headlines of the day, but rather solid data, thoughtful evaluation and consideration of your own personal goals and objectives.

Avoid succumbing to emotions. As the old saying goes, the market is driven by two emotions: greed and fear. During good times, greed often entices investors to enter the market but often at premium prices. During difficult times, many investors will sit on the sidelines out of fear and overlook bargains that may exist, or, worse, liquidate their portfolios
at the market bottom. Keeping focus on your investment plan’s objectives can help during times of emotion. Working towards measurable goals within your plan will help to maintain perspective.

Revisit your plan. Change is inevitable! Financial markets are constantly changing and the prospects of specific companies, industries, or even entire asset classes that may be attractive today may not be as attractive tomorrow. When reviewing your portfolio, diversification should be a broad goal to ensure a healthy portfolio balance and minimize the impact of adverse change.

Over time, your personal needs may also change. As such, your holdings should be adjusted periodically. Don’t forget that your objective is to produce solid returns over time, and not to own particular securities forever.

Keep tax considerations in mind. They can make a difference to the bottom line, especially during times in which high returns may be difficult to achieve. Don’t forget to use tax-deferral and tax-free vehicles (such as Registered Retirement Savings Plans and Tax-Free Savings Accounts), to their fullest extent. Consider the tax status of different forms of investments when you review your portfolio allocation. Dividends enjoy the benefit of the dividend tax credit (for qualifying taxable Canadian corporations). The tax advantage can be significant. As an example, an investor in a tax bracket with 46.41 percent tax on interest income and 29.54 percent on dividend income would need approximately $1.31 of interest income to equal $1.00 of dividend income before taxes are paid. Capital gains are taxed at even lower rates.

At the same time, don’t let tax considerations control your decision making! We’ve seen situations in which investors who are reluctant to sell a holding because taxes will be triggered, overlook important factors such as the changing fundamentals of the security or the need to maintain portfolio balance.

Emotions and Our Investing Decisions

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It’s no surprise that human emotions can often have an impact on investing. Understanding the psychology behind why we make certain decisions can provide some perspective as we pursue the task of wealth building.

It’s no surprise that human emotions can often have an impact on investing. Understanding the psychology behind why we make certain decisions can provide some perspective as we pursue the task of wealth building.

Richard Thaler, a University of Chicago professor, is one of the pioneers of behavioural economics, a field that studies how emotional factors can affect economic decision making. Neuroeconomics explains that we are not biologically wired to make the best financial decisions because the part of our brain that tells us to act rationally can easily be overtaken by powerful emotional impulses. Thaler points out that people tend to be in one of two emotional states: hot or cold. Irrational decisions tend to be made when we are in our hot state. This may explain why we make certain choices: when we aren’t hungry (cold state) we might choose a healthy salad. But once dinner rolls around and we are hungry (hot state), we may select a big bowl of pasta instead. We often overestimate the self-control that is necessary in a hot state.

Likewise, our brains can react the same way when we are investing. Some examples? We may be fixated on a particular sell-price target and refuse to sell a losing position — called anchoring — even though new information changes the target. Or, we may be led into herd behaviour, mimicking the actions of a larger group, even when we would not necessarily make the same decision on our own. This may be one reason why investors sometimes fall into the trap of buying high and selling low. Behavioural finance can also help to explain other peculiarities of human behaviour, such as why we may overlook the importance of saving or why we don’t always put away enough for retirement, even though we know how important it is.

How can we use this knowledge to improve our own investing ways? Being aware of our emotions can help to better regulate them. Those who study behavioural economics claim that many of the world’s best investors have mastered the art of treating their own feelings as reverse indicators. Excitement becomes a cue that it’s time to consider selling, while fear tells them it might be time to buy. Equally important, decisions should be made before entering into potentially emotional situations. This may include sticking to a financial plan during difficult times, refusing to succumb to emotions when the media gets heated or avoiding the urge to procrastinate when updating power of attorney or estate plan documents.

How Investment Advisors Help

Human emotion can be one of the investor’s worst enemies. According to one study that attempted to quantify the impact of human emotion, between 45 and 55 percent of an average investor’s underperformance can be attributed to psychological factors.*

As advisors, one of our more important roles is to help remove the emotion from investing. We encourage a disciplined approach that emphasizes quality, patience and participation to serve investors over the longer term. We implement risk mitigation techniques to help support portfolios throughout any market period, which may include rebalancing to a certain asset mix, limiting the size of any one holding and maintaining quality criteria for assets.

We are here to provide support and keep you on course, so that human emotion doesn’t impact your investing ways.

Source: *Dalbar, Quantitative Analysis of Investor Behaviour, 2013.