10 Steps to take the Emotion out of Financial Decisions


The past six months have proved to be very emotional times for all of us. The pandemic has brought on fear and uncertainty into what the short term may bring in our lives. Some of us are dealing with job loss, decreased income, or a drop-in value to our retirement savings. That is a lot of negativity in a very short period. These negative emotions urge us to make irrational decisions. We make these irrational decisions to find short-term relief in the stress and fears we face today. Our focus as financial planners is to change your outlook from the short term to the long-term goals in your life. The best way to remove fear and uncertainty is to plan. Developing a plan and being aware that there will be speedbumps along the way, help temper any negative emotions you experience in the short term. In our webinar we illustrate the 10 steps that allow you to take the emotion out of financial decisions, and plan for your future based on logic.

Step 1: Determine your risk tolerance

Determining your risk tolerance plays a crucial role in limiting your emotions brought on by market fluctuations. Your risk tolerance will determine how much of your portfolio you tailor towards stocks and how much would be in fixed income made up of bonds & GIC’s. Stocks are the more aggressive portion of the portfolio, that have the potential to earn a higher return but also fluctuate with market conditions. The fixed income portion of the portfolio is the safety portion that does not have high potential returns, but instead it provides safe and steady interest income. Those that have a higher risk tolerance are tailored more towards stocks and with a lower risk tolerance hold a higher fixed income portion. It is important to find a balance that will provide you with a portfolio that will be able to get you to achieve your life goals, while providing the security you need to avoid making irrational decisions based on fear.

Step 2: Diversify Your Portfolio

Now that you have determined your risk tolerance and you know how much of your portfolio would be tailored to stocks and bonds. You should focus on what stocks and bonds to hold in your portfolio. The science of investing says the greater your diversification in different companies, industries and countries, the less risk your portfolio will have. We suggest a portfolio that does just that, allows you to get an investment return that will get you to your end goals, while providing the least risk possible to you. The investment industry has tailored a large amount of their offerings to this philosophy. There are mutual funds or exchange traded funds (ETF’s) that already provide diversification for you. You can purchase one share of a mutual fund or ETF and hold over 10,000+ different stocks and bonds in different countries and industries around the world.

Step 3: Have an Investment Policy Statement

Every good plan has a set of rules to ensure that you do not deviate from the plan. That is exactly what an investment policy statement is. It is a document that holds you accountable to your plan. The investment policy statements illustrate how you will be invested, for how long, how much income is required from your portfolio, and how much risk you can take. This accountability will keep you on the right path to achieve your financial goals.

Step 4: Rebalance Your Portfolio

In our first step we determined what percentage of our portfolio will be stocks and fixed income. However, that is what we initially set the allocation to be. As time goes bye and the assets begin to change with the market, your allocation then changes also. Rebalancing your portfolio is very important because it forces you to stick to your plan and the allocation you originally set out for yourself. Rebalancing is a systematic way to execute a basic financial principal. Buy low and sell high. For example, if the stocks in your portfolio increase then you may be over weighted to stocks. Rebalancing would mean you sell a portion of the stocks and realize those gains and reinvest back into fixed income. Conversely, if stocks fall, rebalancing would have you sell fixed income to buy more stocks at a lower value.

Step 5: Be in a Tax Efficient Portfolio

Now that you have invested into the market, your portfolio will begin to earn taxable income in the form of interest, dividends or capital gains. Each one of these sources of income are taxed differently. Interest is fully taxable, dividends are grossed up and receive a credit, and capital gains are 50% taxable. You need to be proactive to ensure your portfolio is as tax efficient as possible. Registered accounts with the government like Tax Free Savings Accounts (TFSA) or Registered Retirement Savings Plans (RRSP) are tax sheltered. Which means you do not have to pay income tax for any investment income that is incurred in those accounts. Focusing on maximizing these accounts first is important to limiting taxes payable. If you have no contribution room available in your registered accounts, then it is important to ensure the highest taxable sources of income, like interest and dividends, are tax sheltered first.

Step 6: Develop a Budget

Building good financial habits is crucial to achieving financial success. The most important habit is simple, and that is to develop a budget. Developing a budget allows you to properly identify what your major expenses are, where you are spending unnecessarily, and where you can find the potential to save. Due to technological advances it has become easier to develop a budget. The move to digital currency, using credit cards or debit cards, means more of your transactions are tracked by your financial institution. Major financial institutions allow you to download your spending records into a spreadsheet. Which you can then sort into your budget. However, our lives are not static, they are dynamic. Due to the constant change occurring, it is recommended you update your budget annually or as your major expenses and incomes change.

Step 7: Develop Periodic Savings

Once the budget has been developed it allows you to identify how much you can allocate towards savings. We believe in the notion that you should ‘pay yourself first’. That means as soon as you get paid have an automatic deposit set up to your investments. That way the funds are not available for you, and there would be no temptation to spend it. You are now able to budget your remaining paycheck for your expenses. A typical rule of thumb for saving is 10% of your gross income should be directed toward investment accounts each year. Which means as your income increases each year, so should your savings. It is important to note as well, that any money directed towards your RRSP or TFSA should be done with the intention that the funds are for a long-term time horizon.

Step 8: Build an Emergency Fund

In our last step we focused on saving for the long term, but it is just as important to prepare for a rainy day. Building an emergency fund, acts as an umbrella for any client when a rainy day does occur. We know hiccups are going to happen on the road to retirement That may come in the form of job loss, illness, or market instability. So then why not prepare for the inevitable by creating an emergency fund to help get you through these difficult times. An emergency fund is an amount of money (typically worth 3-6 months of expenses) kept in a secure savings account, that is separate from market fluctuations. Having a plan does not just mean planning for when everything is going right, its also being prepared for what can go wrong.

Step 9: Limit Portfolio Withdrawals

A big aspect of financial discipline is only spending what you need. That point is especially true for those that receive an income from their investment portfolio. You must adjust the income you receive from your portfolio as your expenses change. For example, with what occurred recently with the pandemic. A lot of people have seen their expenses fall dramatically due to the nationwide lockdown. With this drop of expenses, income should be adjusted accordingly also. For pre-retired investors that are still saving. They to need to remain disciplined and not withdraw from their portfolio for short term purchases like vacations or cars. Instead, plan and begin to save additional amounts to fund these purchases. Long term investments should remain intact for your long-term goals.

Step 10: Be Aware of Biases

The final step in your plan is to temper your emotions and the way we do that is to be aware of the biases we experience daily. Biases are what warp our reality to believe something is not as it seems. These biases are driven by our emotions and the belief that we know what is best for us. In most cases this is not true. Biases and emotional decisions are the main cause of incorrect financial decisions. An example could be what occurred in March from the pandemic. Many people sold their portfolio’s after the market had dropped significantly. That goes against any basic financial logic, we know we want to buy low and sell high. However, emotions, primarily fear in this example, blur our prospective and lead us to a wrong decision. The best way to combat this is to use a professional. A professional financial planner makes the best financial decision for you and take emotion out of the equation.

Achieving financial success is difficult. We need to focus on saving, taxes, investments, budgets and avoid irrational emotional decisions. All while managing your career and family life. That is why we do not want you to do it alone. Work with a professional that will take on the pressure, the stress, and the accountability to get you to achieve your goals. At The McClelland Financial Group we want you to live the life that makes you happy.

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