Getting emotional about your investment is likely to hurt your returns. Watch the video below that discusses how to avoid emotions like greed or fear when it comes to your investment decisions!
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Products like the Manulife Income Plus or Sunwise Elite Plus sell their solutions based on the concept of sequence of returns. The idea is that the sequence of your investment returns in a significant determinant of whether you outlive your money in retirement.
The math here works because by drawing out your savings each year, you are declining your overall asset base. So both good and bad returns in the earlier part of your retirement have a bigger impact. While the math is all true, the solution isn’t to pay high fees for a guaranteed income product.
But there is something significantly wrong with this concept.
The investment reality misses a key principle.
What is missing is the fundamental fact that after a year or period of poor investment performance, the market will overcompensate with stronger-than-average returns to get back to its “normal” level. What this means is that as long as you stick to your investment discipline, you will get better investment performance after poor performance, and it will then carry you back on target.
The most recent example has been 2008, 2009 and 2010. Based on the sequence of returns research, if your first year of retirement was in 2008, then you lost out on the sequence of returns. The investment industry says instead, you should invest a lump sum amount in a guaranteed product with high fees that will get charged every year of your retirement instead.
What actually happened is that after the TSX total return index returned -34 per cent in 2008, it has averaged 25 per cent returns over 2009 and 2010. Of course, if you invested in a guaranteed withdrawal benefit product, you wouldn’t have been able to invest in anything more risky than a balanced portfolio and you would have missed much of the strong returns of the past two years.
What the real message should be is: Don’t pull your money out of the market after it falls 20 per cent. Better yet, if you have other investments, it might be time to add to your stock position once the market drops 20 per cent.
The key to investment growth is to have some long-term discipline. When it comes to the sequence of returns affecting your retirement income, remember that even after a rough winter, spring always comes.
Everybody seems to “know” that getting emotional about investment decisions and market fluctuations is a bad idea. However, when it comes to making investments, human psychology often plays a large role and investors have a difficult time keeping emotions out of it. It goes without saying that this type of “emotional investing” can lead to very negative consequences.
One of the most common examples of emotions posing an obstacle to smart investment decisions is when it comes to “risk tolerance.” At the first sign of discomfort, many investors run to “adjust their risk levels.” I believe that it is more prudent to avoid this temptation. Because “risk tolerance” is a concept derived from our emotions, and not our intellect, this is every bit as volatile as any human emotions.
Successful investing is to a large extent managing our emotions, which often prompt change at precisely the wrong time.
People also change their “risk tolerance” in reaction to, rather than in anticipation of, market movements, which confirm it is also a lagged response.
Another key observation is that individual investors react to market movements by altering their comfort and “risk tolerance” in line with market cycles rather than against the cycle as should be the case.
Let me explain. As stock prices rise – and especially as they rise sharply, which reduces stock value – the investor perceives that risk in those companies/markets is actually declining, when in fact it is rising.
Since price and value are inversely related, risk is greatest when prices are high; the opposite is equally true. As stock prices rise there is less and less substance supporting the advance. Hence, the curve of a rising stock market is synonymous with rising risk.
Top -performing equities and mutual funds continually demonstrate this counterintuitive trend. Remember Nortel? At its peak people could still not buy enough. And the reverse remains true, which is when the individual investor no longer wants to own stocks and it is precisely at this moment that you can be sure we’re approaching the point of maximum financial opportunity. Just ask Warren Buffett or Peter Lynch when they get excited. It’s certainly not at market tops; that’s for sure.
The following chart illustrates the importance of managing our emotions when investing. Notice that if you relied solely on your emotions, you would drive yourself out of the market just before the point of maximum financial security. As our emotions become more negative, we often forget the bigger picture:
Human nature will ensure that this trend lives on, but through us you have the opportunity to disassociate emotional investment decisions by allowing us to invest professionally and ensure long-term success.
To avoid another investment myth, read about the reasons an age-based investing strategy may not be right for you!
For older investors, segregated funds provide the benefits of a low-risk option with good returns.
What are segregated funds?
Sold by Canadian insurance funds and advisors, segregated funds are a type of investment vehicle that allows your money to grow, while providing certain guarantees such as reimbursement of capital upon death. Put simply, segregated funds offer you the growth potential of a mutual fund with the guarantees of life insurance.
While those interested in avoiding market risks used to focus on GICs and short term bonds, particular segregrated funds now allow older Canadians the full ability to take advantage of the upside of investments with protection against losses!
Advantages of Segregated Funds
a) If you are under the age of 70 as a new investor, most segregated funds guarantee 75% or 100% of your principal investment over 10 years OR when an investor dies, as long as you are under the age 0f 70. For older investors, Empire Life, a large Canadian insurance company, now has a great segregated fund offer with 100% guarantee for all clients who are under 80. This 100% death guarantee has some real value if you are 70+. This benefit becomes very valuable for an individual who is not in great health (there is no physical health check required). This ability for an older investor to still have a 100% death benefit guarantee is crucial to this opportunity as it means that the guarantee might kick in over a much shorter period than the traditional 10 years.
b) Because it is considered an insurance product, the proceeds (on death) for non-registered money will pass directly to your beneficiaries’ tax free and without probate.
c) Segregated funds are not only offered as Balanced or Income funds. Traditional “higher risk, higher reward” asset class funds are also available. For example, Empire Life’s Elite Equity Fund has an annualized return of 10% going back to 1969.
d) Unlike mutual funds, the segregated funds can be reset up to twice a year. If the value of your funds increase, you get to lock in a higher floor value.
e) As an example, Empire Life only charge fees in the 2.5% to 2.75% range. While this would seem high in comparison to an ETF or index fund, the principal guarantees, reset features, and avoidance of probate fees make this investment significantly more valuable for older investors.
If this article was of interest to you, read about why an age-based investing strategy might not be right for you!
