I write a lot about the importance of intelligently managing our behaviour when it comes to dealing with investments.
Most investors, for example, adopt behaviours that lead them to have dismal investing experiences. They buy high and sell low, or they put everything they’ve worked so hard to save into the latest “hot stock,” only to see it suddenly go ice cold. Remember the technology bubble a decade or so ago, when “diversification” meant buying both Nortel and Cisco?
Of course, as someone whose job is lecturing people about their investment behaviours, I must have a perfectly rational strategy in place for managing every aspect of my own finances, right? Wrong. Just like everyone else, I have my own unhelpful behaviours to manage, and it’s no easier for me than it is for you.
Take tax time – everyone’s favourite time of the year. Every year, I get a big refund, which I use to fund my RRSP contribution. This is dumb for two reasons. First, I should make my RRSP contribution in advance, not wait until after I receive my refund.
Second, why should I leave my hard-earned money with the CCRA for an entire year until they get around to processing my refund? This is the same as giving the government an interest-free loan! Instead, I should change the amount of tax I have deducted at source to the correct amount, and use the difference to make monthly contributions to my RRSP.
Sound familiar? If you’ve ever found yourself making the same mistakes over and over again with your finances, perhaps it’s time to figure out what you can do to start managing your financial affairs more wisely.
Personally, I like to trick myself into making good decisions. For instance, when it comes to spending, I always use cash. I don’t particularly enjoy watching my pile of bills get smaller throughout the week. I miss the little guys when they go, and I know they won’t be coming back anytime soon.
As a result, I am much less likely to spend irrationally on things I don’t really need. In fact, statistics have shown that most of us spend 25% less when we use cash instead of credit. That’s a whole lot of extra money we can channel into savings – or spend on something we really want.
The tax refund approach I described above is another “trick” that can help get you where you want to go, sooner and with fewer bumps in the road. If you get a raise this year, another good trick is to have that extra pay deposited directly into a group RRSP or other savings plan. That way, you won’t feel like you’re sacrificing anything, because you won’t even see the dollars you’re putting away, let alone have the chance to spend them.
When it comes to managing your money, try to use your rational side rather than your emotions. Focus on a few core objectives, such as having sufficient diversification and strategies to beat inflation. Then stick to those objectives no matter what happens.
I know, I know; that’s a whole lot easier said than done. One of the hardest parts of successful investing is managing the emotional side. Emotions can be a powerful force, and when you see your life savings losing value or the pundits on the cable news are forecasting the end of the world, it can be tough not to try to sell your way to safety.
So treat your emotions like the real risk they are. Think of turmoil in the markets like a fire. The best way to prepare for a fire is by having a fire drill – namely, a set of decisions you make in advance about what you are going to do in the event of a crisis.
If you map out a fire safety plan, hopefully, if a fire actually happens, you’ll remember your plan and proceed calmly out the nearest exit – rather than, say, hiding under your bed or jumping out the nearest window.
The same is true with your investments. Make an agreement with yourself, in advance, about what you are going to do if the markets go into a tailspin. When bad things are happening, it’s easy to get caught up in the moment. So decide today how you are going to act the next time trouble comes around, then use that decision to manage the inevitable fear (or euphoria) that accompanies market swings.
To put it another way: financial independence is about much more than numbers. It’s about finding ways to manage your actions in both good times and bad. In other words, it is a behavioural challenge – and that challenge is part of what being human is all about.
Alan MacDonald is an investment advisor with Richardson GMP Limited. Alan helps investors with over $500,000. of assets make smart decisions about money. He is the co-author of “The Copperjar System, Your Blueprint for Financial Fitness” available on Amazon.
The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Limited or its affiliates.
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