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January-28-11

Are you an Investor who makes Cognitive Errors?

One of the items on our “Rethink the Way You Invest” inventory involves behavioural finance and lists 8 cognitive errors often made by investors. 

  1. Overconfidence
    There is a difference between confidence, in which you have a realistic belief in your abilities, and overconfidence, in which there is an overly optimistic expectation that you will come out on top (often losing sight that there can be only one winner). Overconfidence in behavioural finance is a belief that you know the best securities to hold and the right time to buy or sell them. This behaviour leads to more frequent trading, higher turnover of a portfolio and lower returns. 
  2. Self Attribution
    Self attribution implies that investment success is due to your talent or foresight, whereas failures are due to outside influences. There’s a saying that you should not confuse brains with a bull market!
  3. Hindsight
    If you believe, after the fact, that an event was predictable, you have hindsight bias. So much has been written on the predictability of the 2008 market decline as we try to satisfy our need to find order in our world – we have to find explanations.
  4. Extrapolation
    Here we see the assumption that past trends will continue. There is a belief that past returns are related to future opportunity. How often have we assumed that the returns of the past year(s), whether good or bad, are sure to continue?
  5. Familiarity
    We tend to gravitate towards things that are familiar to us at the cost of exploring other opportunities. When investing, people often own a large number of shares in their employer corporation. On a broader market basis, there is a tendency to favour domestic rather than international holdings. This bias towards the familiar can result in a lack of objectivity as well as a lack of diversification.
  6. Mental Accounting
    We have a tendency to separate our money into pools, either by source or use, rather than as a whole. We have a separate account for our vacation savings and won’t recognize that paying off the high-interest credit card is more beneficial. If you hold your income investments in your RRSP and equities in a non-registered account, the returns on the two accounts will be different, but that doesn’t matter. It’s the overall return on your portfolio that counts.
  7. Regret Avoidance
    Not wanting to face the possibility of regret, we often end up being paralyzed, or we make hasty decisions. This can lead to holding on to losing stocks for too long in the hope that they will recover, or selling winning stocks because they may decline in value.
  8. Confirmation
    We look for research to support our opinions, often at the expense of seeing the whole picture. In the case of a favourite stock, we may look for analysts’ comments on increasing cash flow or higher dividend payments and not see a potential red flag caused by the loss of a large customer. Having a second opinion to explore both sides of the equation is a valuable tool to avoid confirmation bias.

Working with an investment professional can help to lessen the impact of these cognitive errors – which are essentially very human reactions to things life throws our way.

Member: Canadian Investor Protection Fund (CIPF) &  Member: Investment Industry Regulatory Organization of Canada (IIROC)
 

By: Kathleen Clough | 0 comments
January-07-11

So when should I start receiving my CPP benefits?

With changes to the Canada Pension Plan being phased-in between 2011 and 2016, there is no easy answer to this question. New rules mean new factors must come into play:

If payments begin between age 60 and 65, the actuarial reduction will change. The reduction is made because payments are expected to be paid for more years. Before the changes, the maximum reduction was 30% (0.5% per month before age 65) if a pensioner started receiving benefits at age 60. The new phase-in amounts start in 2012 and are as follows:
 

The maximum reduction if pension is started at age 60 in 2015, would be 36% (0.60% x 60 months).

Assuming a maximum CPP benefit, and based simply on a cumulative total amount received, the “crossover” under the new rules would be reached at age 73 or 74. In other words, if you live past age 74, the cumulative benefit will be better if you start CPP at age 65 than at age 60. Here’s the chart:

If payments begin after age 65, monthly payments will be higher, since payments are anticipated to be paid for fewer years. Beginning in 2011 (note the different starting date than the reduction for before age 65) payments will increase by:

The maximum increase if pension is started at age 70 in 2013 would be 42% (0.7% x 60 months)

In this scenario, the crossover age is around 81. 

 

The drop-out provision in calculating benefits will change. This provision allows the exclusion of a portion of zero or low earnings from the contributory period (from age 18 until retirement). Starting in 2012, the number of years of low or zero earnings that are automatically dropped from the calculation of CPP pension will increase from the existing 15% (up to seven years) to 16% (up to 7.5 years) and in 2014 this will increase again to 17% (up to 8 years). 

Under current rules, if CPP is taken before age 65, the pensioner must have substantially ceased working in order to collect. This Work Cessation Test will no longer apply, starting in 2012.

A new Post-Retirement Benefit is being introduced, starting in 2012. Under current rules, once CPP payments start, they will not change if the pensioner returns to work – new earnings would be exempt from CPP contributions.

Beginning in 2012, those pensioners who are under age 65 and who return to the workforce will be required to contribute to this new benefit, as will their employer. If return to work is between 65 and 70, additional contributions will be voluntary. Other factors:

  • Self-employed beneficiaries will pay both employer and employee contributions
  • Contributions will entitle the beneficiary only to Post Retirement Benefit payments. No eligibility or increase in other CPP benefits will be created, nor will these contributions be subject to credit splitting or pension sharing.
  • Each year of work will provide an additional post-retirement benefit that will begin the following year and will be paid for life.
  • The Post Retirement Benefit will be added to an individual’s CPP retirement pension, even if the maximum pension is already being received.

This provision will become another factor to be considered when looking at starting CPP early. If CPP starts at age 60 and the pensioner subsequently returns to work (or continues to work, since no cessation test will apply), it may be preferable to receive an increased pension at 65 than to supplement the reduced pension with the Post-Retirement Benefit.

As with many areas of retirement planning, there is no easy rule of thumb. Each case should be evaluated to determine the best solution for the individuals involved.

By: Kathleen Clough | 28 comments