Take Emotions out of the Investment Equation

Investing involves risk. But a well-constructed financial security plan contains structural elements specifically designed to address potential risks while focusing on long-term growth. This approach relies on formulas, not emotions.

The foundation for creating a sound financial security plan is determining your risk tolerance. Financial security advisors and investment representatives require you to fill out questionnaires that estimate willingness to accept risk while exploring your financial objectives. The key is finding the right balance – and understanding this process is vital. That’s why emotions need to be taken out of the investment equation.

Why it’s important to start investing at a young age

Time is a powerful tool in reducing risk and an important reason to start investing early in life. Generally, the younger you are, the more aggressive you can be. As you get older, your portfolio should steadily shift to more conservative investing. This is a mathematical process.

Financial markets, especially stock (or equity) markets, can bounce around from day to day and sometimes they take sharp drops. Historically, markets recover over time, albeit with some short-term volatility.

  • The foundation for creating a sound financial security plan is determining your risk tolerance.

The value of mixing it up

Diversification is a bedrock technique for mitigating risk. Holding a large number of investments and types of investments can help lower the overall impact if a particular investment gets into trouble.

Take stocks: Owning shares in several companies spreads out risk. Moreover, you can offset the stocks of newer companies with those of more established companies. Low-risk investors may be willing to invest in a couple of higher risk technology start-ups with growth potential if the rest of their equity portfolio contains larger, more established companies.

Size isn’t the only factor. Investing in different industries adds another layer of diversification. If energy companies are facing short-term problems because a warmer winter is causing natural gas prices to fall, companies in other sectors may benefit from the drop. Investing in different countries is another way to diversify your portfolio.

Mutual funds and segregated funds are common solutions for diversification. They contain shares from a large number of publicly traded companies and may specialize in specific industries or countries. Funds available cover the gamut of risk, from high-risk emerging markets growth funds to conservative funds.

Investment Emotions

Using diversification to your advantage

Asset allocation is another powerful diversification technique. Financial portfolios are divided into three main categories: equities, fixed income (which includes bonds) and cash. Fixed income investments offer less upside but they are generally more stable; this is especially the case when it comes to government or high-quality corporate bonds. Many people invest in bonds indirectly through mutual funds.

Cash is the third category. Cash or cash-like instruments, such as term deposits, offer limited but guaranteed growth. Individuals with a very low risk tolerance – such as people nearing retirement – may hold a significant amount of their portfolio in cash. Cash also offers a safe way to park money for shorter-term goals, such as saving to buy a house.

The financial challenges of getting older

As you age, your investment horizon shortens. At age 25, you have the ability to assume more risk in your portfolio. You can’t rely on time to smooth out bumps once you approach retirement. As a result, your portfolio should gradually become more focused on conserving capital and generating income. That means moving to less aggressive investments and eventually increasing your holdings of fixed income investments and cash.

Why it’s important to ignore irrational urges

Even if you have the best-laid plans in place, investors can find themselves tempted to try something new. Common missteps include:

  • Trying to time the market: Professionals can’t know when prices will go up and down and neither can you.
  • Selling when an investment falls in value: In actual fact, this could be the time to buy.
  • Chasing hot rumours. Best tip ever? Develop a solid financial security plan and stick to it.

Going on autopilot with the right investment plan

If your investment portfolio is set up properly, it should almost take care of itself over the long term. Contributions can be transferred automatically and proceeds, such as dividends, are reinvested.

Thoroughly examine your overall investments once or twice a year to make sure asset allocations remain at desired levels. A jump in stock prices can be good for the portfolio but you may find yourself overly invested in equities and needing to move some of the money into more conservative investment options.

Spending time working with me to customize – and fully understand – a sound financial security plan allows you to spend less time thinking about money. It’s a big part of enjoying financial independence.

Asset Allocation the Key Investment Strategy

Landing on the right investment strategy boils down to balancing your expectations for growth with your tolerance for taking risks. But even the most aggressive portfolio should gradually take on a more conservative approach as retirement age approaches.

An investment portfolio may contain many types of investments, all of which fall into three main categories.

Risk versus reward

Stocks, or equities, offer the biggest upside for increasing in value. However, it can be a bumpy ride. Short-term dips in the stock market can be steep. Over time, however, the long-term trend is up. Fast and scary price drops in share prices become mere blips over 20 or 30 years.

Risk varies greatly within this category. Some equity-based mutual funds clearly identify themselves as growth funds, taking on more risk in an attempt to find companies with the highest potential. At the other end, some mutual funds aren’t shy about calling themselves conservative. Their holdings focus on well-established companies with solid fundamentals. The potential isn’t as high but investors face lower risks.

Middle ground

Bonds, or bond-based mutual funds, find a home in most portfolios. They’re inherently less volatile – well suited for protecting principals – but offer limited rewards. They’re classified as fixed-income instruments because owners receive regular payouts, which can also be re-invested.

As with equities, growth potential and risk varies widely within this segment. Government bond funds offer quite low risks but returns are also limited. Corporate bonds have greater potential and more risk. Investors comfortable with risk may opt for high-yield, or “junk,” bonds issued by fledgling or distressed companies looking to raise capital by offering high but uncertain yields.

Cold cash

Cash, savings accounts, guaranteed investment certificates and money market funds are the safe haven in a portfolio. The risk of losing your principal is extremely low. Many of these investments are guaranteed and losses in the others are rare.

The biggest risk in parking money in cash is inflation. If the inflation rate is higher than your return, you’re losing money in real terms. However, for people already retired, cash is an important category.


Balancing act

My prime objective is to recommend an asset allocation that makes sense for your situation, including age, need for returns and tolerance for risk. Model investment strategies run the gamut of aggressive growth (all stocks) to ultraconservative (all fixed-income securities such as bonds, as well as cash vehicles).

Willingness to take on risk varies greatly. Some people are very comfortable with risk while others shy away from the stock market completely. This risk profile is a central element in designing the best asset allocation.

  • A 20 – something person may be more risk averse than a retiree but a longer horizon gives a young person the ability to take on more risk.

Beyond risk

Younger investors have a greater capacity to take on risk since their investment window can be 30 years or longer. Indeed, a 20-something person may be more risk averse than a retiree but a longer horizon gives a young person the ability to take on more risk. As a result, a large share of their holdings may be in equities.

Conversely, retirees who fly to Las Vegas twice a year may have little choice but to hold most of their investments in bonds and other fixed-income instruments to both generate income and preserve their capital.

Thus, for any given willingness to take on risk, a portfolio should start shifting to a more conservative approach as retirement approaches.

Needs-based decisions

Asset allocation is also a function of need. I can play a central role in helping determine the amount of savings you’ll need to support your lifestyle in retirement. Many factors may come into play, such as your willingness to downsize your home or expected inheritances.

First, the good news

Canadians, on average, are living longer. Statistics Canada reported in 2014 that a 65-year-old woman should expect to reach 87, up two years from 2001. A 65-year-old man today can expect to live to 85, also up two years.1

Longer retirements may require more savings. This increase in need could require that you incur more market risk.

Custom tailoring

Successful investing does involve some risk. I will assess your individual situation and help you design the optimal asset allocation to meet your goals, and help it evolve over time while staying in your comfort zone.

As you get closer to retirement, proper planning can help ensure the risk built into your portfolio will steadily diminish, leaving you free to start planning the next chapter in your life.