Behavioural finance is a field of study that suggests extreme stock, real estate and bond market anomalies are tied to psychology. A prominent psychological bias in behaviour finance is ‘herd mentality,’ which advocates that people follow popular trends (despite the necessary due diligence) that cause dramatic market rallies and sell-offs.
Every investor wants to optimize their portfolio’s return, but the best way to manage money is to be aware of the relationship between risk and return. By managing our risks, we are better equipped with addressing unpredictable scenarios that negatively affect our finances.
How can we control risk?
- Know Yourself: Draw on your past experiences to determine how you react during crisis situations and figure out what it will take for you to meet your goals. After reviewing your current situation, ensure that you are taking on the right amount of risk to achieve your goals.
- Carry the Appropriate Amount of Insurance: Ensure that your insurance policies are up-to-date and sufficient given your circumstances. Review whether or not your spouse and dependents’ needs are covered in the event of your disability or passing.
- Have an Emergency Fund: Segment your savings into those needed to cover short-term expenses and those that can be invested for the longer-term. Set aside an additional 3 months’ worth of expenses in liquid savings in the event of an emergency.
- Diversify your Investments: Long-run asset returns tend to revert to their respective means but short-term fluctuations can be quite volatile. Diversification across asset classes, geographies and investment styles is a great way to maximize returns per your desired risk profile.
- Don’t Time the Market: By extending your investment time horizon, you become less subject to short-term price fluctuations that are a result of unpredictable human behaviour.
- Use Credit Wisely: Debt is not always a bad thing, but be aware of the interest you pay. Pay off credit card debt in full each month and review mortgage, line of credit and/or loan debt regularly to ensure that you can sustain your payments if interest rates increases.
There will always be times when you find yourself in a crunch. By preparing yourself well for emergencies and the unknown, you can reduce these occurrences and more easily ride out the rough spots until your situation improves.
“You only have to do a very few things right in your life so long as you don’t do too many things wrong.” – Warren Buffett
Cattelan Private Wealth Counsel
HollisWealth®, a division of iA Securities Inc.