We know how your mental health can affect the way you deal with money. If you’re feeling low or depressed, you may lack the motivation to manage your finances. It might not feel worth trying. Thinking of the future is hard when you have no motivation to do so. Spending may give you a brief high, so you might overspend to feel better. You might make impulsive financial decisions. If your mental health affects your ability to work, this might also reduce your income and put more pressure on you.

We also know your financial situation can affect your mental health. Certain situations might trigger feelings of anxiety and panic. Worrying about money can lead to sleep problems. Money problems can affect your social life and relationships. You might feel lonely or isolated, or like you can’t afford to do the things you want to.

You don’t need to have significant debts for money to affect your mental health. We know all too well the vicious cycle of depression and debt. Nor are you guaranteed to be happy, just because you have money. Even for those who have money, the emotional connection to money, and the way you think about money, influences your decisions. And these could have huge impacts on your future state of mind.

You might feel guilty for spending money, even if you know you can afford it. Or, you might feel guilty for seeking support, even if you know you need it. You might feel stressed if you’re under a lot of pressure to support yourself and others. And worn down from working so hard to generate the income just to sustain your family. What is it all for?

Steve Jobs had money. “I reached the pinnacle of success in the business world. In others’ eyes, my life is the epitome of success. However, aside from work, I have little joy. In the end, wealth is only a fact of life that I am accustomed to. At this moment, lying on the sick bed and recalling my whole life, I realize that all the recognition and wealth that I took so much pride in, have paled and become meaningless in the face of impending death.”

OK so Steve Jobs is an extreme example, but a key question to ask is: What is it all for? Is it for your family’s security? Is it for charity and philanthropy? Is it for the biggest holiday of your life (AKA retirement)? And have you got a plan to get there? Is your plan balanced enough to allow you the flexibility to live a little?

You might find it helpful to take some time to think about how you feel about money and why. For example, if you’ve struggled with money in the past or didn’t have much money growing up, this might affect the way you feel about money now. You could try answering these questions:

• Are there certain times when you’re more likely to spend money?
• Are there certain times when you’re more likely to save money?
• How does it feel when you spend money?
• Do you feel differently when you’re spending and saving?
• What are the emotions and feelings you think of when you think about money?
• Which aspects of dealing with money make your mental health worse?

Once you’ve done this, you might start to feel like you understand your habits and patterns around money a bit more. Knowing these could help you plan ahead for difficult times.

Having plans give us structure and a framework to work within. We can allow flexibility, and allow ourselves to be human. Using trusted advisers who understand money but also the emotional impact of money is important to keeping balance. And remember, what one person does is not necessarily the same and what others should do. We are all individuals. We all have to find our own balance.

Let’s pick Lauren as an example. She is 35, married and is currently earning 100,000 CHF per year. She is pregnant and wants to understand how the 60% contract when she returns to work after maternity leave is going to impact her pension provision and associated benefits.

Current Situation:

She earns 100,000 CHF per year. The coordination deduction is currently 25,095 CHF (this reduction is to coordinate the first and second pillars) therefore the coordinated salary is:

• 100,000- 25,095 = 74,905 CHF

As she is 35, a minimum of 10% is paid into her second pillar therefore 7,490 CHF is being contributed on an annual basis.

60% Contract:

60,000 CHF earnings per year. Lets assume the coordination deduction hasn’t increased since she returned to work, therefore the coordinated salary is:

• 60,000 – 25,095 = 34,905 CHF

She is now 36 and still in the 10% category so 3,490 CHF is being contributed to her second pillar on an annual basis.

Impact:

Lauren’s Second Pillar Retirement Savings

Although Lauren has reduced her contract by 40%, her annual second pillar contributions have decreased by 53%.

Lauren’s Second Pillar Insurable Benefits:

Children’s disability pension, children’s orphans’ pension, Lauren’s disability pension and the survivor’s pension in place for her husband will all also decrease as these are based on the new coordinated salary.

What does this mean for her and her family?

Lauren will be the main carer for their child and if Lauren was to become sick or die the family would have less protection in place as this is calculated on the new lower figure under the new contract.

At a time when they need more protection in place, they will have less.

What can be done?

In Lauren’s case she started a third pillar with insurance to protect her family on her death. Now if she dies before retirement the family will receive a 200,000 CHF lump sum and she is using the savings provision to save for her own retirement in line with her attitude to risk.

Of course, if Lauren’s circumstances were different my recommendations could have also been different – but that’s the benefit of a financial review

What fees could you pay? Does this 1% cover the custodian fees? What about the investment management fee? And the underlying fund fees? The big one and no one speaks about is the financial planning fee – what is that? Is that included in that 1%?

If you want to manage money by yourself its easy to keep all fees below 1%. You just need to worry about the custodian (where do you hold your investments – avoid banks if you want to pay less than 1%) and the underlying investments (shares = no cost / collective investments 0.2% – 1% p.a.) But do you have the knowledge to manage your own investments? Are you confident enough to avoid common behavioral traits that ruin any best laid plan? And do you know why you’re investing in the first place? What is your Plan?

Outsource the management or if you receive financial planning advice and fees creep up. But not necessarily by much.

The discussion about fees is an important one and knowing what you pay and to whom is important. Not just for your own piece of mind but for accountability. And lump sum fees should never be built into products – you must be able to cancel them. I’m amazed at people who tell me 1% a year is expensive. People think they pay far less than they actually do and they receive little to no service. I look at portfolios that are charged at 0.5% management fee and I look under the bonnet and they pay over 2.5% per year within collective investment fund charges – some fees are explicit and some hidden – do you know where to look?

Also and by no means a small point is the significant impact of financial planning. Not only from a time saving perspective (your time) but you can save significant taxes too. Why are you investing if you can buy back missing years of your second pillar? What’s your tax rate 25-40%? Wouldn’t you prefer a tax saving and a plan to maximize these and balance this with your investments over time? Pay for advice and you might end up investing less than you would otherwise, saving tax and time. You may end up paying for a service that helps you achieve what you want and saves you money. You’d want to pay for that service? Right?

Value. That’s what is important. Not the size of the fee.

Data from the FinaMetrica (a renowned risk profiling platform) spanning different market conditions over time, demonstrates remarkable consistency in the average scores. Consistency is a good thing. If a client’s risk tolerance changed every time they came to an advisor’s office (or joined them on a Zoom call) it would be very difficult to give consistent defensible advice.

A client’s risk tolerance is how emotionally comfortable they are with taking risk. Imagine a continuum from reducing risk to avoid unfavourable outcomes up to embracing risk to achieve higher returns—where a client sits along that continuum is your risk tolerance. Risk tolerance is a psychological trait, a distinguishing characteristic that makes each person different, much the same way I could be on a scale somewhere between introverted and extroverted.

Like other psychological traits, risk tolerance tends to be stable over time and market conditions. Most people do not change from being an introvert one day to an extrovert the next, nor does their risk tolerance change. Not all questionnaires that claim to measure a client’s risk tolerance are created equal. Psychometrics—the marriage of psychology and statistics, provides standards for evaluating tests, sorting the good from the bad. A good test should be both valid—measures what it purports to measure, and reliable—measure consistently over time with accuracy.

FinaMetrica published data built on more than 1.2 million risk tolerance tests globally from January 2008 through to April 2020, spanning the Global Financial Crisis (GFC) of 2008 to the boom leading up to the current Covid-19 crash. Risk tolerance, globally and across the major markets of Australia and New Zealand, United Kingdom and United States, stays at an average of around 50 (on a scale of 1 to 100). Sure, there is some variation, but not in magnitude nor very correlated to market movements. Interestingly, because FinaMetrica has had thousands of the same clients take the test both before and after a crisis, researchers have confirmed this consistency is not only on average but that individuals largely test the same after a crisis as before.

A risk tolerance test that follows short term market volatility is dangerous for clients and advisors. If a poorly constructed test was applied during bull markets and it made people look more aggressive than they really are, when a downturn comes, they might panic sell and crystalize losses. Conversely, if a faulty test were applied during a down market and it indicated people are more risk averse than they truly are, their advisor could invest them more conservatively than they should, and returns could be unnecessarily sacrificed. Poor risk tolerance tests correlated to the market are also challenging for financial planning professionals and their firms, who must satisfy regulators that the tool they are using is fit for purpose. This is hard to do if the results change every time the client is tested.

So why do many advisors believe a client’s behaviour changes in a downturn and that they become more risk averse? Or why do so many clients do the wrong thing, panic and sell more equities in a market crash if risk tolerance is stable? Maybe it is not the client’s risk tolerance that has changed (as indicated by the FinaMetrica data) but the perception of risk in the marketplace. Clients might be quite willing to live with a 30% drop in their portfolio value but when CNN tells them this crisis could lead to the next Great Depression, no wonder they can become scared!

COVID-19 has brought a market shock and there will be others to come. Advisors who have performed a valid risk profile for their clients (and as we discussed many clients have not completed a proper risk assessment) find that clients are more likely to stay the course. In all cases advisors can and should provide an important role helping clients manage uncertainty to deal with the fear generated in the media, through proper guidance and education. If assessed properly, risk tolerance will be a stable factor in any financial planning conversation, steering the focus towards long term risk and return expectations; restraining excitement during upturns and dispelling unnecessary fears during downturns.

After years of ridicule in the watering holes and forced lectures of other people’s opinions (mainly Tottenham fans), I came to see the situation in a different light. I concede, Arsenal are no longer a top European side, for now!

I needed to view the situation through a different lens. It’s hard to pull up the anchor and reassess one’s own view, but this can be far more important when it comes to decisions that will affect the rest of your life, your finances.

I often hear the anchored statements that prevent action, ‘investing is for fools’, ‘you’ll lose money’, ‘it’s not for me’. Similarly frightening statements that push action – ‘I’m missing out on the bitcoin train’. Often these statements are based on a past experience or an event that has tainted their view. The financial crash in 2008, Greece’s Debt Crisis, The Corona Virus Pandemic, the bitcoin boom, – too much weight is put on an event or past experience which taints reality.

This anchoring can have devastating consequences towards achieving what we want and we limit our lives and our future plans in the process. If you don’t invest, you don’t grow your money. Einstein was right – compound interest is the 8th wonder of the world. Similarly, if you invest poorly or without diversification, you’re at risk. I bet there are plenty of people out there who invested when a bitcoin was at 58,000 USD (Spoiler alert it’s now 35,000 USD at time of writing).

Now I’m not saying you must invest nor that bitcoin is a bad investment. We just need to be more self-critical and understand when we anchor. If speaking to others helps to view situations in a different light, do it. It could be the best way to pull up that anchor and sail towards more fruitful seas.

Before we concentrate on overcoming this issue, we must understand why it occurs. Believe me, you will see this happening in every mundane corner of life, procrastination, diet, exercise and financially. Over 25% of people claim they do not have savings and the most common reason for not building savings for the future is that it can feel like a loss right now. This cognitive effect has detrimental impacts on retirement funds. People have not saved enough for retirement and subsequently compromise their standard of living upon retirement.

Another consequence of the present bias is rushing into investments. Crypto currency is easily accessible; gratifying the urge to invest in one simple click of a button – this often is not a thought-out plan! Subsequently the present bias will be at play when we see the markets drop. An overwhelming urge to vacate the bad situation and associated feelings. Sell and run (sadly locking in the loss!). The present bias is an emotionally driven, cognitive influence that can easily steer us into bad decisions.

So…you have read this far. Now the question should be resonating, how do I control this?

Its relatively simple, it all boils down to a plan. The reason why you are doing something must outweigh the urge for instant gratification. It could be putting the snack aside so as not to spoil your dinner, a smaller rental to build a deposit for the dream home or simply a little here and there to secure your financial independence. Whatever the motivation, it all boils down to the plan and remembering the true reason ‘why’.

Imagine you have invested into a shop that is open all year round but the only item you sell is ice-cream. We can guess what your profits will look like generally – low in the cold months and high in the warm months like the graph below.

The range of profits from our shop are not steady. Although we can expect higher returns when the summer months are warm – what if there is a cool summer? (Remember May this year) Your profits are likely to be even less to help sustain you through the poor months. “Your eggs are all in one basket”

For some people they may have lots of other shops and they do not mind specialising here. For others this would worry them, particularly if it is their only shop – if it rained all summer they wouldn’t be able to sleep at night.

So, for those that would be concerned, let’s diversify your shop a little. This means we are aiming to have a steadier return and set ourselves up so if we have unseasonal weather it won’t impact our shop as much. To do this let’s use a little investment theory. We will start selling something that is negatively correlated with ice-cream profits. This means generally speaking the expected movement of these will be opposite to ice-cream. This will bring the volatility of the profits down – decreasing the risk. You have already read the title, so let’s include umbrellas in your shop’s stock.

We can now reasonably expect a graph like this*:

The result is you have more steady profits throughout the year and even if you have a cold Summer or a mild Winter you are a little more protected through diversification as demonstrated by the red line in the graph below:

It is important that you understand how to structure your portfolio and the correlated risks within it. Most don’t have access to the tools that financial planners and independent investment managers do, therefore it might be worthwhile having a review of your own portfolio to see what correlated risks you’re exposed to. It could save you from a cold dry year when neither ice creams or umbrellas are particularly useful!