Article – Adviceon Library

Cognitive Biases and Investment Decisions

Cognitive errors in how people process and analyse information can lead them to make irrational decisions that can negatively impact business or investing decisions.¹

Anchoring Bias Some investors anchor their investment decisions by fixating on a targeted result. Calculations that determine results ahead of investing in a fund portfolio can result in only thinking about future fixed results, disallowing for ongoing flexible guidance. An advisor can study the historical data, performance, and trend changes within the sector(s) in which the fund performs.

Recency Bias When we overvalue the latest information available about investments, we can develop a bias about what we’ve heard most recently and may not be looking at the big picture. In uncertain times, having an experienced advisor guide you in assessing the potential based on valid analytical data is wise.

Loss Aversion Bias The fear of losing money while investing can cause harm to inexperienced investors; for example, in March 2020, when the Dow Jones Industrial Average (DJIA) quickly dropped below 20,000. On November 23, 2020, the DJIA edged back over 30,000, higher than pre-March, 2020, as did the S&P 500. Investors who do not exercise patience during such times as the above period may experience an irretrievable loss. The Loss Aversion Bias only focuses on avoiding losses. Such bias often misguides an investor to miss out on good opportunities for gains.

Confirmation Bias If an investor looks only for information that affirms existing beliefs while discounting contradictory information, important facts may be left out of a decision process. Talking to a certified advisor may make you less apt to miss essential findings that may help you decide for the best. Advisors have access to many investment analysts and pertinent information on a broad field of market investment knowledge.

Bandwagon Bias Investor tips can circulate among others who may not be tried and proven investors. If not assessed carefully, one might make a hasty investment decision. First, ask your advisor for their opinion – and make an informed decision.

¹ Investopedia

How can indebtedness jeopardize a business?

Business Banking relationships are essential. Many businesses acquire a bank loan collateralised by the total value of their assets to survive financially. Suppose a business owner with a good relationship with his bank dies. In that case, the bank may call the loan if the business begins to experience financial duress and defaults on repayment.

Avoid collateralising personal assets. The prospect may not be favourable when the loan equals or exceeds the value of the business and personal assets.
Following established rules, a bank may ask a business owner to collateralise a loan, not just with business assets and land, but with additional personally owned assets, which may encumber a spouse’s co-owned assets.
Add to that a possible collateralising of any assets of a son or daughter (and spouses) who also share in family business ownership.
Family members of small business owners can also lose their financial security if the business defaults on loan repayments.
If you own a business, avoid being held hostage by the lending institution financially or forced into liquidation.

Can life insurance reduce the risk associated with the family business debt? You can solve this in a family business such as a farm by insuring the oldest and succeeding generations using joint-first-to-die life insurance policies or individual plans. Where there are non-family businesses, each owner/partner should be insured to cover the debt. When the life insured dies, the tax-free life insurance proceeds can be used to pay back loans, win back ownership, and discharge any personal assets liens.

What if there is a Critical Illness? Also, for the same reason, consider purchasing a Critical Illness Insurance policy for each principal business owner and key persons. This product could provide a substantial sum of money to pay off debt if one were to experience a significant illness such as a heart attack or stroke. If an individual were incapacitated, they may need to be bought out by a partner or an heir (a buy-sell agreement should exist). The risk of a loan being called increases when an owner-manager is critically ill, and the bank manager loses confidence in the stabilising influence of that owner.

Note: Life insurance contracts should be compared with an advisor to understand what portion of the life insurance is tax-free.

Group Benefits and Employee Addictions

Ten percent of the Canadian population report symptoms consistent with substance dependency. In the USA, the ratio is similar.

Source: Statistics Canada

Employers may watch for:

regular absence patterns
late for work
poor focus affecting production
confused about directives
appearing tired or stressed, or lazy
not collaborating well with other employees
a short temper
increased mistakes or wrong interpretations of duties

Have a policy for your employees who may suffer from substance abuse. Employers may have to find ways to approach, address, manage and/or get counsel for an addicted employee. The policy can also advise that your company suggest accessing an organization’s employee assistance program (EAP).

For an employee who suffers from an addiction to be eligible for group benefits, a group benefits plan may require that the employee disabled by addiction be introduced to a treatment program.

Group Critical Illness Insurance

Group Critical Illness Insurance

News of a critical illness can be very upsetting to a plan member. When you can offer them financial support during a difficult time with a Group Critical Illness Insurance plan, the employee can manage with the extra resources better.

Group Critical Illness Insurance Allows the critically ill to focus on recovery rather than worry about finances. It pays a lump sum amount when a plan member is diagnosed with a covered life-threatening illness. The insurance benefit payment can be used as the plan member chooses. It is available to plan members and dependants.

Once a claim is approved for someone diagnosed with a covered illness, he or she is paid a lump sum. The money may be used however the person chooses, such as private nursing or medical care, modifications to a home or childcare costs, allowing the person to focus on recovery and managing the illness.

You can offer Group Critical Illness Insurance to plan members and their dependants while giving them an option to purchase additional coverage for themselves and their spouse. Benefits can be structured as either a flat amount (i.e. $25,000 to $100,000) or a multiple of the plan member’s salary.

Covered illnesses

Most standard plans cover these common major illnesses:

Heart attack
Stroke
Coronary artery bypass surgery
Cancer

Dependent on the plan, it may cover the illnesses above, plus:

Alzheimer’s disease
Aortic surgery
Benign brain tumour
Blindness
Coma
Deafness
Heart valve replacement
Kidney failure
Loss of independent existence
Loss of limbs
Loss of speech
Major organ transplants
Motor neuron disease
Multiple Sclerosis
Occupational HIV
Paralysis
Parkinson’s disease
Severe burns

How to prepare to qualify for a mortgage

When you apply for a mortgage, there are several questions that a lender may ask that you can prepare for. They will want information relating to:

The primary information they will need.

Employment and income
A summary of your outstanding debts
Cash reserves, bank account cash, investments, and other assets
The down payment that you have on the property you are purchasing and is it your own money
Will the loan also be to consolidate any debts?
What will be the use of the property?
What is the equity you now have in your current home, if applicable?

Employment and income.

Who is your employer?
How much income do you make, and can you provide payment receipts/stubs?
How long have you been working at your job?
Is your income a salary or other income such as sales commission?

Your liabilities.

What are your outstanding debts?
What commitment level per month do you have to pay debts?
What is the cost per month for auto loans?
How much of your income goes to pay off credit cards, and what is the gross credit card debt?
How much money will be left after you pay for your down payment and closing costs?
If you are refinancing debts, how much debt will your mortgage cover and reduce your equity?

What you will use the real estate for:

Will this be your residence?
Will you rent a portion of the home out?
Is it an investment property?

Property type

A condominium?
A duplex?
A single dwelling?

Responses that can work in your favour:

I have steady employment with the same employer for two-plus years.
I carry little debt with a debt-to-income ratio of 25 per cent or less.
The mortgage is only for a home purchase.
My down payment of at least 30 per cent of the sales price with my own money.
The cash reserves will pay several months of the mortgage payments once the property closes.

Responses that can work against you:

Self-employed or contract worker.
High debt with credit cards maxed out, with a total debt-to-income ratio of more than 30 per cent.
The property will be renovated for rental use.
The liquid cash situation is tight once everything is paid after we close the deal.

Mortgage planning cautions

Mortgage planning cautions

Don’t overburden your cash flow. North Americans are taking on far too much debt, partly influenced by lower borrowing costs. When money is cheap, people take on more debt; when interest rates rise, they reduce debt.
Rates Rates Rates Please do your homework and check our mortgage rates. It is far too easy to take out or renew a mortgage from your local bank that you visit regularly. When you get a mortgage renewal letter from your current lender, work at negotiating a contract or comparing lenders who may have fewer restrictions plus at a competitive rate. A broker or lender may offer much lower rates. A few basis points can make a big difference when it comes to paying off a mortgage.
As a mortgage specialist, I can help. For personalized financial advice, you should speak with a licensed mortgage broker to compare and sell mortgages. He or she will focus on your specific needs, which is just as crucial as a reasonable rate.
Read the fine print. Blessings or potential problems can be ascertained in the details. Know what you’re signing. What are the prepayment options, late payment fees, and refinancing penalties? Is a variable rate mortgage convertible into a fixed rate? If so, how will the lender calculate the fixed rate?
Maximize the frequency of your payments. Consider paying bi-monthly versus monthly to shorten your payment amortization period.
Further, reduce your amortization period. After paying a mortgage for five years, try to reduce the amortization period by those five years. In this way, a 25-year mortgage amortization period is reduced to 20 years.
Know your mortgage facts. It is essential to know the facts about your current mortgage and one that you may renew. Check out what your interest rate is and what your monthly payments are per month. Find out when your mortgage is up for renewal. In certain cases, there may be a penalty for getting out of your mortgage early or restrictions. A change in your rate, such as moving from a variable rate to a fixed rate, might be a good move. Know your total income, liabilities, debt repayment costs and expenses. The lender will then determine how much you can afford. A good rule of thumb is that your mortgage payments should not exceed more than 40% of your net income.

A Mortgage Shoppers To-Do List

Before shopping for a new home, getting a preapproved mortgage lined up several weeks before closing is essential; you also want to look at what mortgage brokerages are offering. Often you can find a competitive rate with excellent terms provided by an advisor who offers mortgages.

Often the mortgage rates advertised by your bank are higher than rates that a mortgage broker can find. Also, avoid restrictions on making lump-sum payments or high fees if you need to leave the mortgage before renewal.

Your checklist:

If you own a current home, get it evaluated
Get your credit score from Equifax or allow a brokerage to acquire it
Taxes and assessments from the last two years
Careful accounting of your household income
Assess your liabilities, such as credit cards and loans
Assess your assets held in investments and savings accounts
Have enough for a down payment on hand
Also, have enough cash for closing expenses for legal fees, mortgage and title insurance, and transfer taxes.
Budget for extras such as buying new appliances or condo fees if applicable
Research the meaning of mortgage contract terms as it applies to each specific company offering a lower rate. Know about:
- Variable rates
- Fixed rates
- Open versus closed mortgage
A line of credit works well if you are going to renovate.

Establishing your Mortgage down payment

Establishing your Mortgage down payment

Accumulating a down payment for a first-time homebuyer or a reno can be a challenge. Many younger adults have other obligations such as student loans, rent, and basic monthly expenses.

What are some tactical options to enable you to acquire a down payment:

First, consider what you can afford By calculating what you truly can afford for a down payment or a renovation plan if you are considering staying in your current home, we can look at the refinancing scenarios. By calculating your post-reno value, you may be eligible for more mortgage money.
Your RRSP may have the answer The Home Buyers’ Program (HBP) allows first-time home buyers up to $25,000 withdrawal (double that for a couple to $50,000). This manoeuvre is tax-free from accessible RRSPs. Consider that you will be taking on the responsibility of establishing a repayment plan. Canada Revenue Agency (CRA) allows the HBP insofar as you pay back your RRSP funds at approximately 1/15 of the funds borrowed per year, over 15 years. If those monies are not paid back on time, they will be taxed as income at your going rate.
A tax-free gift of money Gifted funds from a parent or a blood relative may provide a downpayment. A written document must be provided, indicating that the funds are a gift without any requirement to pay back the money.
A loan from a friend or relative Perhaps a grandparent or a friend can loan you the down payment with a fair interest rate, with a manageable repayment agreement. Consider also using other borrowed funds or using an unsecured line of credit.
Consider a lower-priced starter home Consider a fixer-upper or a lower priced first home. With current lower interest rates, pay down the mortgage as quickly as possible. Then with your good credit rating, apply your new equity to purchase your dream home.

The necessity of a licensed mortgage agent

Many Canadians are stunned by what has happened to the Canadian Real Estate market in our key cities. Some think it has been wealthy foreigners buying up our best houses and lands. Others believe the problem is due to the misdirected legislation federally and provincially — an absence of reasonable laws designed to protect the home prices for Canadian citizens from being artificially inflated. Still, others think it is the low-interest environment offering near-zero interest rates responsible for the crazy inflation. Or is due to houses being quickly flipped, increasing the value sometimes by up to or more than double what the home initially agreed to be sold for? During the pandemic, there was an extreme bidding up of house prices. It may be a mixture of all of the above.

Many intense studies are underway. Josh Gordon of Simon Fraser University has studied all potential causes. Historically, there is a lack of essential data available, despite being in an age when data influences our life decisions.

Michael Babad, of the Globe and Mail, published as far back as Apr. 21, 2016, that millennials — children of baby boomers — find it difficult, or near-impossible financially, to live in Vancouver or Toronto.

Millennials who are just starting out and want to buy a home may find it hard to afford a mortgage. Michael Babad goes on to note that:

“Paying for a house has become so difficult that saving for a down payment takes years in Toronto and possibly decades in Vancouver, new research suggests: Toronto is troublesome, and Vancouver positively out of sight, according to a National Bank Financial study, although it is far easier in other Canadian markets such as Montreal and Calgary” and “in Toronto and Vancouver, affordability for homes other than condos is the worst in National Bank records dating back to 2000, based on first-quarter data”.

National Bank’s senior economist Matthieu Arseneau and associate economist Kyle Dahms analyzed comparative real estate prices and increases, in contrast to incomes, required down payments and the mortgage payment required as a percentage of income (referred to as the MPPI). Vancouver and Toronto markets pop off the grid compared to other prices.

Based on the time it takes to save a down payment for a single-detached house, semi or townhome, you might consider using a mortgage specialist.

National Bank’s senior economist Matthieu Arseneau and associate economist Kyle Dahms, analyzed comparative real estate prices and increases, in contrast to incomes, required down payments and the mortgage payment required as a percentage of income (referred to as the MPPI). Vancouver and Toronto markets pop off the grid compared to other prices.

Based on the time it takes to save a down payment for a single-detached house, semi or townhome you might consider using a mortgage specialist.

We are only a click away. Contact us today and we will be happy to help you.

Understanding mortgage amortization

Amortisation refers to the number of years it will take to repay your mortgage in full. Based on your down payment and current legislation, amortisation periods can run up to 30 years.

Shorter amortisation periods allow you to accelerate paying off your mortgage. The other advantage is that you will pay less interest the more the timeline shortens. The tradeoff is that you will pay more for your monthly payment.

The mortgage payment and method need to unify with your overall financial plan. For example, a mortgage of $400,000 at an average fixed rate of 5% and a 30-year amortisation will have a $2,134 monthly payment, and you will pay $368,506 interest over the 30 years. Reducing the period to 25 years, you’ll pay more at $2,326, but your total interest expense will be reduced to $297,924, saving $70,882.

In our calculator section on this website, we have mortgage calculators, which may prove helpful for planning.