Behavioural Finance – Page 2

Market pullback? Financial planning!

This is the time when financial planning really, REALLY matters

There is no getting away from it: When investment markets turn negative, it doesn’t feel good. Though we know that there will be ebbs and flows in the economy and in our investments, it can feel overwhelming while it is happening.

So, without denying the reality of the market numbers, let’s calmly shift our focus from IT to YOU.

Informed by your financial planning

Your investments are one part of your financial life. And your financial life is one part of your … life. The big tool we have available to manage that journey is the process of financial planning.

That means understanding where you are currently, so that you can live responsibly within your present means. It also means looking to the future and the needs you will have then, saving for that eventuality, and managing those savings in an informed way.

The informed way that we manage savings is more commonly known as “investing.”

Yes, your investments are critical to your life’s journey, but let’s be candid: You are not about to spend everything in your investment portfolio today, just because of market movements yesterday. By the same token, if – or rather when – there is a bounceback, that’s also not a personal signal to you to spend immediately.

Diversification has many faces

Every investor who has worked with a financial advisor will have had the conversation about the benefits of diversification. It’s the ‘not-all-the-eggs-in-one-basket’ wisdom that advocates not overly focusing on a single security, or economic sector or geographic area.

As importantly, the concept of diversification applies to you personally, as much as to what is in your accounts. There is a natural progression over a financial lifetime – learning, earning, saving, investing and spending – but at any given time you will be engaged in more than one of these activities.

To the point, if you have a well-rounded financial plan where each of these is properly addressed, then the current fluctuation of your investments should not throw you into a panic.

Looking even closer at the investments, time is also a diversifier. As your advisor will counsel, your investment approach should always take into consideration your comfort with risk and the timeline for when you expect to use that money. Not only will you not be withdrawing everything right now, you won’t be taking it in a lump sum at any one point in future. Practically, you are setting yourself up for a flow that will carry on over the course of many years.

Maybe you’re in the midst of that drawdown mode now, or maybe it’s years ahead. The good news is that time generally works in your favour to allow your investments to recover, even in the face of a significant market pullback. The key is to have an up-to-date investment policy statement and financial plan so that your portfolio continues to fit your evolving needs.

Stay informed so you can stay the course

In that light, I am certainly not suggesting you ignore market movements. Observe them, inquire into them and learn from them. That includes listening to and learning from your own emotional response.

Some present anxiousness is to be expected, but you still need to have the comfort and confidence your portfolio is constructed to suit your long term needs.

Rudiments of retirement readiness

The route from present-you to future-you

In our early years, retirement isn’t much more than a concept somewhere beyond the curve of a distant horizon. Often it’s portrayed as a time to pursue adventure and realize dreams.

Then as we move forward in our lives, that horizon takes shape. We survey the landscape, chart a direction and take stock of the resources and tools we need for a successful journey. Without completely abandoning the romanticism, we must turn to the practical, and in today’s world that means money.

So while retirement is about more than money alone, it remains at the centre of determining when it’s possible to retire, and what’s possible when you get there.

What does today’s retirement look like?

Individually and as a society we are living longer. Medical advances have reduced infant mortality, eliminated many life-threatening diseases and conditions, and extended lives through better health care. Today, we’re less concerned about surviving to retirement, and focused more on thriving through it.

We will have more years in our retirement, and healthier bodies to enjoy that time. We’re no longer just parking ourselves in rocking chairs and on park benches, so we need to think consciously about how we’ll spend our time, and how we’ll pay for it.

And while health has improved, eventual decline is inevitable. That too will extend out for a longer time, and generally more decisions and adjustments will be required along the way. It’s vitally important to be aware and prepared on many levels: socially, emotionally and financially.

Consider as well that there are more multi-generation families living at the same time now than ever before. Whether you’re an elder, a youngster, or one of the sandwich generations in-between – that interconnectedness will have an impact on everyone.

How do you save within your means?

Let’s consider present you and retired you, and the financial trade-offs between. To take adequate care of both of you, there are three principles that you can use as a guide: Live within your means now, save to fund your future self, and live within your means when you get there.

That may seem patently obvious, but it can be difficult to put into action without a clear picture of your current financial state. That’s where budgeting comes in, but it need not be an overwhelming undertaking. To get started, you need an overall view of major income sources and spending, and then you can get more granular and strategic with your budgeting as you become more comfortable with it.

Most often your principal income source is your own earning capacity. Live healthy to protect this greatest asset, and also consider disability and life insurance for contingences you can’t control.

Do you understand your tax position?

Tax can be a complicated topic. While you don’t need to become an expert, you do need to understand it sufficiently so you can make educated decisions.

For starters, you earn your employment and business income in pre-tax dollars and make your personal purchases in after-tax dollars. As well, your income – and therefore your tax bracket – will usually go from low level in your early working years, up through peak career, and back down in retirement. Knowing this, you can be more realistic and targeted in your saving and spending choices.

This also gives you context for public pension and private savings programs, in terms of what’s available to you, their proportionate value, and the tactics you can use to get the most out of them.

What can you expect from public pensions?

There are two main public pension programs: Canada Pension Plan (CPP) and Old Age Security (OAS).

CPP is a publicly-run insurance plan for workers. You pay premiums out of wages during your working years, for which you are entitled to a retirement pension. The maximum annual pension beginning at age 65 in 2017 is $13,370. You can begin as early as age 60 but if you do that the amount is reduced by about a third, or if you delay to age 70 you can get about 40% more. Presently, the average actual pension is $7,727.

A person is entitled to a full OAS pension after 40 years of Canadian residency after age 18. The full annual pension at age 65 is just over $7,000 (it’s indexed quarterly), though you can get almost a third more if you delay to age 70.

These programs provide a firm foundation for retirement, but most people will want and need to supplement this with private savings.

How do you build your private savings?

Under a registered pension plan, an employer is responsible for making payments to retired employees. The value of the pension is negotiated between employer and employees, and can be quite complex. The employee has no tax liability while working, and simply pays tax on the pension when it is received in retirement.

You may also make tax-deductible contributions to a registered retirement savings plan (RRSP). It is based on your earned income, the maximum contribution room being $26,010 in 2017. Investment growth is tax-sheltered. Withdrawals are taxable, usually taken by moving the RRSP to a registered retirement income fund (RRIF).

If you are a Canadian resident over 18, you may contribute $5,500 annually (current in 2017) to a tax-free savings account (TFSA). Contributions to a TFSA are not tax-deductible, but growth and withdrawals are tax-free.

Where does your home fit in?

Whether you rent or own, housing is usually your largest expense in any given year and over a lifetime. Renting is a pay-as-you-go proposition, exposed to year-to-year market movements. By owning, you can defray a large portion of your future shelter costs by allocating some of your savings into home capital. As a bonus, capital gains on your principal residence are tax-free when you sell, though in the meanwhile that home capital can’t be spent.

Deciding whether, when and how to sell a home can be an emotional prospect, on top of financial concerns.

And as large as that is, there are many smaller decisions that in sum can be equally challenging to contemplate. Armed with a deeper understanding of the retirement rudiments outlined here, you can be better prepared to meet those challenges and more confident in the decisions you make as you head toward and live in your retirement.

Like gramma’s shortbread, financial advice needs the human touch

My gramma – yes, that’s how I spell it – was an amazing baker. My mom was an amazing baker. Me? Well, I do my best to pay homage to that pedigree.

In preparation for our wedding, my wife and I decided we would make “Gramma’s Shortbread” as a truly personal bomboniere for our guests. But try as we might, our results were more granular and chewy than the melt-in-your-mouth memories I had from my childhood. So I called my mom for advice.

“Dear,” she began, “a mixer is a wonderful appliance, but my mom only had the strength of her fingers and the warmth of her touch. Put away the beaters and use your hands.” It turned out great, though I’ll concede that it wasn’t quite as good as mom’s or gramma’s.

Financial advice is personal

In our high-tech world, it is tempting to believe that tools can replace people, even in something as personal as your family’s financial future. But like the electric mixer, tools are only as useful as the skilled hands operating them, and often the most important part of the exercise is the human aspect.

Despite having the ingredients and recipe in hand, we needed guidance to fix our shortbread. A phone call to my mom sufficed to rescue our five-ingredient foray, but with all due respect to bakers, there are far more inputs and far greater implications in the field of personal finance.

It is asking much more, and arguably too much, for mere phone, web or email contact to be an adequate connection between you and your financial advisor. If it’s about your personal needs, shouldn’t that professional relationship have a personal element to it?

Why the relationship matters

A financial advisor works with you, not on you. At a minimum your advisor must have the training, licensing, financial tools and access to products and services that can fit your financial needs.

Beyond that, you need to connect with the person.

This will give you the comfort to be candid about yourself and your desires, so that you obtain advice appropriate to your circumstances. Equally important, you will then have confidence in the recommendations you are provided, while remaining conscious of the need to evaluate them on their technical merits.

From recipe to results

Once you have come to a decision, it can still be an anxious moment to get going. Remember though, that like a recipe on an index card, a plan is only paper until you put it to work.

One character trait that is critical for a financial advisor to be effective is the ability to motivate people to take action. It is a skill that builds through professional experience, and the more you can observe and appreciate it, the more inclined you will be to trust and act on it.

After that, the continuing human contact you have with your advisor will allow you both to monitor developments and make any required adjustments, so that you remain on track.