This is the first of a four part series on how to invest your money. The main focus of this series of articles is to discuss the psychology of investing, how to get started, finding your strategy, and building your portfolio. I hope this can be a resource for many people who are looking for information on how to invest their money.
How To Invest Your Money: Psychology Of Investing
When asked how he made his fortune Warren Buffet said, “To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.”
Keeping your emotions in check while investing sounds easy enough in theory, but until you’ve witnessed your own investment portfolio gain or lose more than 20% of its value, you won’t know if you have the stomach for it.
While it’s true that the stock market has provided the best returns for long term investors, the returns do not come without risk.
Investment Profile and Risk Tolerance
When you first get started investing you will typically meet with a representative at your financial institution who will get you to fill out an investor profile to determine your risk profile and potential asset allocation strategy.
After determining your age, current net worth, investment knowledge, and main purpose of your portfolio, the questions will turn to your attitude towards risk. Examples of this risk assessment include questions about your willingness to accept losses in your portfolio, and your patience to withstand a market drop and recovery.
After completing the questionnaire, you will receive a score that will correspond to the type of investments that match your profile.
For a low risk tolerance individual, the recommendation will be to invest in GIC’s and other fixed income products.
For a medium risk tolerance, you might be steered towards a balanced growth or monthly income fund. And for the high risk tolerance folks, the advice will be to invest in any number of domestic or foreign equities.
Fear and Emotions
Many people can claim to have a high tolerance for risk when simply filling out a questionnaire. But until your own money is on the line, you just never know how you will react.
Look no further than the most recent market crash in 2008-2009, in which many investors lost up to 50% of their portfolio from the highs in September 2008 to the lows of March 2009. Tuning out the market noise and the negative news headlines is more difficult than it seems.
Fear and emotions can take control of you and even though many people believed they had the stomach to withstand the ups and downs of the market, most did not, and they ended up taking their losses, selling their equities and moving into safer investments like a high interest savings account, or GIC’s and bonds.
Instead of tuning out the noise they succumbed to fear and made an emotional and irrational decision. Now hindsight is 20-20, but the stock market has rebounded over the past two years while GIC’s and high interest savings accounts haven’t been paying more than 2% interest over that time.
Reality Check
If you’re willing to invest your money in the stock market you need to understand the risks involved. The stock market is not for short term savings goals, and it’s not a quick path to riches.
If you can’t handle the thought of losing money during the tough times of a bear market, then you should just stick with savings accounts and GIC’s.
But if you can practice the patience and discipline to stick with your strategy for the long term, and you can ignore all of the market and media noise that can play on your fear and emotions, then you stand a good chance of being a successful investor in the stock market.
In part two of this four part series on how to invest your money I will talk about how to get started with an investment portfolio, depending on your age, current financial situation and future goals.
Have you checked out a copy of your credit report lately? It’s a good idea to review it from time to time (even once a year) with the prevalence of identity theft, but even to just check for errors.
You can get a copy of your credit report from equifax.ca (the main source for banks and other lenders) and also transunion.ca. There is a charge for an immediate on-line report, but you can get a free copy within a couple of weeks by printing out the request form and mailing it to them.
Your Credit Report: Knowing What To Look For
First look at the personal identification information listed on your credit report. Make sure your name, address, current employment, birth date and SIN are correct. On the mailed version part of the birth date and SIN are X’d out for your protection.
Next it’s important to look at the credit enquiries that have been made. Your bank and credit card company may make enquiries in order to update their information and perhaps increase credit limits.
Related: Top Cash Back Credit Cards
You authorized this when you originally signed all the application documents (do you remember?). However, there may be enquiries from unauthorized companies that are fishing for information and you need to be aware of these.
The rest of the report will include your credit history – credit cards, loans and lines of credit, and bankruptcy and collection information, if any. It will show when the account was opened, your own or joint account, the credit limit, outstanding balance, when the creditor reported, last payment made and payment history. Check it for accuracy.
In my bank lending days I dealt with more than a few people who were surprised to see collection notices from fitness clubs, book and CD/DVD clubs and other such places that require a long term contract that they didn’t know about. Even if the company has disappeared the accounts are still sent to collection – unfair but still done.
Your Credit Rating
Financial institutions use a numbered scoring system called a “beacon score” to assess your credit worthiness. The higher the score, the easier it is to receive a loan, credit card or mortgage and to perhaps negotiate a favourable interest rate.
What affects the beacon score?
- Number of enquiries – Too many enquiries can suggest a credit seeker – someone who applies for credit from numerous sources. So be aware of this when you are interest rate hunting at various banks. If an application is completed, a credit enquiry will definitely be made and you will have to explain.
- Detrimental history – Bankruptcy, collections, late payments (more than 90 days), garnishment of wages, and even orderly payment of debt will automatically bring your score to zero. You may be able to borrow if you have a good explanation and have had a clean record for the last several years.
- Alternative lenders – The presence of finance company information will reduce your score. Be aware that deferred payments at places like furniture and electronics stores are contracts that are sold to finance companies for processing and payment collection. Even if you pay in full within the “don’t pay” period the information is still on your record.
- Too many accounts – Carrying high balances and having accounts over their credit limit can hurt your score. Even if you pay your credit cards in full each month there may be a balance showing depending on the reporting date. Keep your cards to a minimum and don’t spend over the limit even if the credit card company allows it.
- Too many credit cards – Especially retail charge cards. Make sure that inactive and cancelled cards are actually closed.
Take Responsibility To Ensure Accuracy
Information is purged from the credit report periodically – inquiries and voluntary deposits such as orderly payment of debt after 3 years; credit and banking information, collection accounts and secured loans 6 years from last activity; bankruptcy 6 years from discharge. There are some exceptions to these time periods depending on the province.
If you find any errors or inaccuracies in your credit report first contact the credit company involved. Unfortunately they are usually slow to respond so you need to keep at them until it is corrected or deleted.
If you are unsuccessful in resolving the matter you can send your explanation to the credit bureau and they must include it on the credit report.
This morning Finance Minister Jim Flaherty will introduce new mortgage rules designed to reduce Canadians’ high household debt levels.
- Mortgage amortization periods will be reduced from 35 years to 30 years
- The maximum amount Canadians can borrow to refinance their mortgages will be lowered to 85% from 90%
- The Government will withdraw its insurance backing on home equity lines of credit
The new regulations hope to help Canadians get rid of their mortgage debt before they retire by significantly decreasing interest payments over the life of the mortgage. They also want to encourage more responsible lending and borrowing while encouraging people to increase the equity in their homes.
Related: Why Our Debt To Income Ratio Is Misleading
For the past year the Bank of Canada has warned us that Canadians have taken on too much personal debt.
Whether they’re buying their first home, upgrading their house, taking out an investment loan, or using a home equity line of credit for renovations or personal use, it seems like everyone is taking advantage of this low interest rate environment.
The ratio of household debt to disposable income has now reached 147%. Meanwhile interest rates have had nowhere to go but up for a while now, but due to the delicate global recovery they have only been inching up slightly.
As my wife and I are just about to start building our new house I was interested to see this announcement from the government.
The change in amortization rules will not affect the costs of buying a house for us as we plan on taking a 25 year amortization with our new house. But the change in refinancing rules from 90% to 85% could have an impact on our plans to stay in our house while we build the new house.
As I discussed in a previous post, in order to stay in our house while the new house is being built we would need to take out most of our home equity to pay the home builder during the 3 phases of the building process.
But since we can now only take out 85% of the value of our home (minus the current mortgage), this decision will impact what we can withdraw by $12,500.
Since our home builder only takes 4-5 months to complete a new house, we will need to ensure that we are able to sell our existing house during that time frame.
I’ve been following the comparable homes in our area on MLS and am confident we will be able to price our home just below market value in order to trigger a quicker sale.
We will be working with our home builders’ new program where they will get us listed on MLS but we will be responsible for taking calls from other realtors to view our house. In return we won’t pay any real estate commissions.
The only catch is that the home builder wants input on our sale price and wants updates on any progress from showings and offers.
It’s obvious that the Canadian government wants to tighten up lending practices and get our debt levels down in case interest rates start moving up again.
For the most part I agree with the direction they’re moving, since it was their own loose policies of 40 year amortizations and 5% down payments that fueled the housing boom in the first place. I just see these new regulations as a return to sanity.