Financial Optimisers - New Era Financial Planning

A Financial Advisor’s Guide to Life Insurance – What you Need to Know

Written by Daniel Thompson on February 20, 2025. Posted in Financial Advice, Financial Optimisers, First Home Buyer, First Time Investors, Next Home Buyer.

What is Life Insurance?

Life Insurance helps protect against certain risks if something were to go wrong. You essentially pay an insurance company a certain amount (usually a monthly ‘premium’) for them to pay you an amount if you need to make a claim. This can be for your car, home, health and even life. For example, most people have home insurance, where an insurance company will pay a certain amount if something happens to your home, such as a fire that destroys it.

How does it work?

Insurance is a risk management strategy – you pay a monthly amount to an insurance agent for the ability to make a claim and have money paid in the event of something happening. Normally we take out insurances on things that we can’t fund ourselves, such as needing to rebuild your home in the case of a fire.

The way it works is usually like this: you take out an insurance policy with a company for a certain amount and to cover you against certain things happening (they might call these ‘events’) and pay a monthly or yearly cost to the insurance company in return for them agreeing to pay you a certain amount in the future if you need to make a claim.

Eg: You want to cover the cost of rebuilding your home if it is destroyed by flood, fire or hurricanes. You estimate it will cost $500,000 to do this so take out insurance to cover that amount. The cost of this is $1,000 per year, which you pay to the insurance company. You don’t get this back if you don’t make a claim, however you have the peace of mind that if something happens you can claim and the insurance provider will pay you out $500,000 to rebuild your home.

Types of cover – Life Insurance, TPD, Trauma & Income Protection

As financial planners we look at insurances as part of an overall risk management strategy. This strategy includes having an emergency fund, protecting things like your home, car & health, and then making sure that you are covered financially if you were to pass away or unable to work. These last types of cover fall into the ‘Life Insurance’ basket and are predominantly made up of the following:

Life Insurance: Pays you a certain amount of money (usually as a one off) if you pass away. The money will go to the people you nominate as your ‘beneficiaries’ (normally your partner and/or kids) and is usually used to pay off any outstanding loans, cover funeral expenses and provide some financial comfort for the family.

Total & Permanent Disability (TPD): This also pays you a one-off amount, but in this case if you are so seriously injured or unwell that you are unable to ever work again. This can get specific on when it will be paid out so it’s best to do your research or get some help, but the main idea is that if you can’t work anymore, for example due to a car accident or major illness, you will get a payout which can be used to clear any outstanding loans, help with medical & rehab costs, and provide some financial comfort to you and your family. There are 2 types of cover here:

Any occupation cover – this will pay out if you are unlikely to work again in any occupation that you are reasonably suited for based on training, qualifications and experience. It is slightly harder to claim under this option, however is slightly lower cost as a result.

Own occupation cover – this will pay out if you are unlikely to ever work again in your current occupation. It is easier to claim on this however is slightly more expenses, but in our opinion worth it!

Trauma/Critical Illness Insurance: This also pays out a one-off amount, but this is specifically if you suffer a serious illness, such as cancer, a heart attack or stroke. This type of cover is to help with your recovery and to pay for things like medical & rehab costs and some financial support while you are on the mend.

Income Protection: This pays part of your income if you’re unable to work because of a disability caused by illness or injury. It can help pay the bills so you can focus on getting better. It usually kicks in after 1-3 months of being sick, so isn’t necessarily to cover time off for things like colds. Income Protection can pay you for a certain amount of time (such as 2 years) or until you are back at work, whichever is the earliest.

Payout options: Most options pay you 70% of your income if you can’t work, however this amount can differ a little bit so is worthwhile getting help on your options. There is also what is known as a ‘benefit period’, which is basically how long you are paid for. You pre-select a timeframe that would be the maximum amount of time your get paid, such as 2 years, 5 years or until you are 65 years old. If you are able to go back to work within that timeframe then the payments will end as well, however if you are unable to go back to work after the benefit period ends you will need to look at other funding sources, such as the Disability Pension.

Waiting Periods: This is how long you wait until your income protection starts paying you once you make a claim. It is not like private health cover, which may have a 12 month waiting period before you can claim on certain items – most policies allow you to claim as soon as it is in place, however there are options have the monthly payout start 30-90 days after you are first sick/injured. The benefits of the longer ‘waiting period’ is a lower cost of insurance, however you need to make sure you have enough savings and/or sick leave to cover that period.

Payment options

These types of insurances can usually be paid either out of your bank account/credit card, like car & home insurances, or from your super fund. You may have some insurances inside your super fund already, however there are some restrictions on what types of insurance can be held within super, as well as the benefits payable and access of these. We usually like a mix of paying for insurances inside super and personally to get an ideal blend of affordability, tax benefits (for example income protection is usually tax deductible) and simplicity at claim time.

Our Insurance Philosophy

We look at insurances as part of an overall risk management strategy. This strategy includes having an emergency fund, protecting things like your home, car & health, and then making sure that you are covered financially if you were to pass away or unable to work. As a rule of thumb, we believe around 3% of your total household income is appropriate to spend on the ‘life insurance’ category, and around 5% of your income on total insurances (including car, home & health). This leaves you with 95% of your income to pay your mortgage & bills, save, invest & spend.

Our insurance philosophy is built around the idea that insurances are needed to put you back into the financial position that you would have been in if the event that occurred never happened. For example, what financial position would you & your family be in if you didn’t have to have time off work, or were diagnosed with cancer, or worst case passed away? This is largely based on the financial blueprint that we put together for people, however as a rule of thumb covers against the following:

If you pass away – leaving your family with enough to be debt free (the financial blueprint always aims to be debt free within a certain period) and support themselves for a few years
If you can’t ever work again – having enough to pay out your mortgage and any other debts and cover the medical, rehab & any other costs incurred due to the injury / illness.
If you suffer a serious illness – covering the medical, rehab & other costs associated with the illness.
Income Protection – covering your income while you are off work and recovering. This income is still needed to pay the bills, and there may be other medical expenses due to the injury or illness that need to be paid for as well.
Financial comfort – we usually look at some money to provide financial comfort & support on top of the above, so people don’t have to worry about money and can focus fully on recovering. Studies have shown that money-related stress can slow down the recovery of injury & illness, so we want to alleviate that as much as possible.

Types of risk that can affect your ability to earn an income and derail your financial plan

Unemployment

There isn’t any type of insurance that can protect against this. Instead we like to build cash reserves to utilise in these instances (3-6 months of living expenses), plus make sure you are always employable by improving your skills & training.

Accident/Illness or other Health issues

Short term (0-24 Months) – Ways to Get ready for short term:

Cash buffer (3-6 months living expense)
Sick leave
Insurances that pay out if you can’t get to your own job for a few months

Long term (24 Months & Beyond)

Insurance that will take away some big-ticket financial pressure e.g. debt, major medical and kids expense if you cant get back to your own job even after 2 years, as your current debt & Kids education plans is based on the income you generate in your current job, not based on a job an occupation therapist from the future, paid by an insurance company says you can do.
Insurances that pay out if you can’t get to any job for the foreseeable future

Having insurances Inside super vs Outside super – best of both worlds?

Some insurances can be held within your super fund, such as Life, TPD & Income Protection Covers. This can help with affordability of insurances, however some of the covers aren’t as good when held within super due to legislation requirements at claim time. For insurances held within super, they must meet the ‘Superannuation Industry Supervision Act’ (also known as ‘SIS’). In a nutshell, even though the insurance might pay out because you have made a claim, the super fund may not pay the money to you because you haven’t met one of the requirements to be paid. All insurances owned through super get ‘released’ (paid) to the super fund first – this is something most people don’t realise and is a little quirk of the system. So it is very important to make sure you will be able to get your money when you need it.

For each of the main covers:

Life insurance – This is usually ok to be held within super because at claim time it’s fairly straightforward (when you’re dead you’re dead!). If paid to your spouse or someone who is financially dependent on you the payout will be a tax-free lump sum regardless of if it’s through super or outside, and there isn’t any trouble with the super fund paying the money to your family as death is one way that you can access money from your super. The main downside when holding Life Cover through super is there are only certain people can be nominated as a beneficiary – essentially immediate family or someone who is dependent on you – and adult children may be taxed on the payout.
TPD – Here is where things start to get tricky. With TPD through super you can only make a claim if you are unable to work in any occupation that you have training, experience or qualifications in. When holding it outside you are able to have it set to claim on your own occupation, which means it is easier to claim. Because TPD cover is usually linked to Life cover though, it is usually easier to have it through super with life cover. So we generally like to ‘link’ the TPD inside super & outside to help with affordability and get the better claim ability at the same time.
Trauma – this cannot be held within super due to legislation, so is only able to be held and paid for personally.
Income Protection – Like TPD, things can get a bit murky here. There have been a lot of changes with Income Protection legislation recently and there are so many nuances within different policies now. They are all fairly streamlined in being able to claim a maximum of 70% of your income, however some policy can drop that amount depending on how long you are paid for. You can hold Income Protection through super, however we generally recommend that it is held outside because it is tax deductible, and it is a bit quicker at claim time because you get paid directly. For those that have affordability issues we as a minimum recommended the ‘linking’ of the Income Protection inside super and outside, like the TPD.

Paying for cover through super

For cover that you hold through super (usually life insurance & TPD), the cost will be taken from your super balance. For small amounts this may not be too much of an issue, however over time it can add up to large amounts and deplete your super balance. Due to this we like to recommend adding some extra to super to cover some or all of the costs. For example, this can be done by salary sacrifice, which also reduces the amount of tax you pay, or in a way where you qualify for a Government Co-Contribution if eligible, which can help pay some of the costs.

‘Super linking in more detail’

What is Super linking?

This is the ability to ‘link’ certain insurances (specifically TPD & Income Protection) inside super and outside. The reason people do this is to help pay for the insurances through super, whilst getting the better claim definitions outside super.

What is the benefit?

What is the SIS act’s condition of release – this is the techinal term for when your super fund can pay you your money and or insurances. By law super is to fund your retirement, so normally cannot be accessed until a certain age (currently at least 60) and also needing to be retired if you want to access your money between 60 & 65. There are a handful of other ways to access super early, with 2 of the main ones being death and permanent disability. If you have these insurances within super you will be assessed by both the insurance company on whether the claim is successful, and after that from the super fund on whether they are able to release the money from your fund. The insurance provider will have to pay the claim to your super fund, who will then decide whether they are allowed to pay you based on the laws of super access.
Legislative risk – there is a small risk of the insurance company paying a claim and the super fund deciding not to release the funds. Usually the risk is more that the insurer will deny the claim, especially in the case of the ‘any occupation’ TPD cover noted previously. A lot of super funds have this as standard; we generally recommend having the better ‘own occupation’ definition so increase the likelihood of the claim being successful.
Chance of claim – there is a better chance that you will be able to claim on the ‘Own occupation’ TPD definition, as it will kick in if you can’t work in your current job, not just any job you are qualified to do. Because of this we prefer this option and have built it into our insurance philosophy. Most super funds do not off er this option directly though, which is why it is important to look into the right provider and not just take the standard insurance that is offered through super.

Conclusion

Life insurance & the other types of cover can provide a great safety net for you, however we believe they are part of an overal risk management & financial plan. We aim to get the right blend of required cover, affordability & tax benefits with all the insurances that we look at.

Should You Add More to Super? The Simple, Smart Moves you Need to Know

Written by Daniel Thompson on November 8, 2024. Posted in Financial Optimisers, Retirement.

Superannuation is one of the most powerful tools for Australians when it comes to building wealth for retirement. For many, contributing more to super can lead to a larger nest egg, tax savings, and peace of mind. But is it always the right move? In this article, we’ll cover the pros and cons, walk through a tax-saving example, explain ideal contribution rates, and share practical tips on how to increase contributions painlessly. Let’s explore if you should add more to super.

Pros and Cons of Contributing More to Super

Understanding the benefits and limitations of the superannuation system is crucial for making an informed decision on whether you should add more to super.

Pros:

Tax Savings on Contributions and Earnings:
Contributing extra to super can provide tax benefits that enhance your savings. Salary sacrifice and personal concessional contributions (taxed at 15%) are generally lower than the standard marginal tax rate (MTR), making super contributions a tax-efficient way to save for retirement. Additionally, earnings within super are taxed at only 15% (or 10% on capital gains if assets are held for over a year), rather than your usual income tax rate.
Tax-Free in Retirement:
Once you reach the age of 60, withdrawals from your super are generally tax-free. And with the current $1.9 million transfer balance cap, you can enjoy a tax-free retirement income stream within that limit, allowing for a substantial, tax-free nest egg.
Long-Term Investment Strategy:
Super is designed to be a long-term investment, growing over decades. With a diverse portfolio, your super benefits from compounding, potentially delivering more robust growth than short-term investments.

Cons:

Restricted Access:
Super contributions are locked away until you reach your preservation age (usually between 55 and 60), meaning you can’t access this money to meet immediate needs or unexpected expenses. This is a key consideration, especially if you anticipate needing funds for significant life goals before retirement.
Annual Contribution Limits:
Concessional (before-tax) contributions are capped at $27,500 per year, and non-concessional (after-tax) contributions are capped at $110,000 per year, making it important to avoid over-contributing to prevent additional tax penalties.
Total Lifetime Limit:
The total amount you can hold in your super tax-free once retired is capped at $1.9 million, known as the transfer balance cap. While this is a generous amount, it may limit those planning for very high retirement balances.

Example: How to Add More to Super & Save on Tax

Let’s look at a real-life example to illustrate the tax benefits of contributing more to super.

Consider someone earning at a marginal tax rate (MTR) of 32.5%. If they salary-sacrifice an additional $100 a week into their super, they’ll contribute an extra $5,200 annually. Here’s how the tax savings add up:

Tax Savings on Income:
Normally, the $5,200 would be taxed at 32.5%, equating to $1,690 in taxes. By salary-sacrificing into super, however, that contribution is instead taxed at the concessional rate of 15%.
Effective Tax Benefit:
At 15%, the contribution incurs $780 in tax, resulting in a tax saving of around $910 for the year. Not only is this saving, but it also means more of your earnings go directly toward building your retirement savings.

Current Super Contribution Rate and the Ideal Benchmark

The current mandatory super contribution rate is set at 11.5% and will increase to 12% by July 2025. However, many financial planners suggest aiming for a 15% contribution rate to comfortably meet retirement goals.

Adding an extra 2-3% from your income through voluntary contributions could help reach this benchmark. For many, achieving a 15% rate is manageable through small adjustments, like increasing contributions with pay raises or making a commitment to salary sacrifice.

How to Contribute Extra to Your Super

There are two primary ways to increase your super contributions:

Salary Sacrifice:
This is one of the simplest and most effective ways to contribute extra to super. Arrange with your employer to deduct a portion of your pre-tax income directly into your super, reducing your taxable income and allowing the contributions to be taxed at the concessional 15% rate.
Personal Contributions:
You can also make after-tax contributions to your super, which are known as non-concessional contributions. This method allows you to contribute any additional amount directly from your post-tax income, up to the cap of $110,000 per year.

Painless Ways to Add More to Super

Boosting your super doesn’t need to impact your day-to-day cash flow significantly. Here’s a simple strategy:

Allocate Future Pay Rises to Super:
Here’s a way we help our members add more to super: Whenever you receive a pay rise, consider putting 0.5% to 1% of your salary into super. This incremental increase means you’re investing more for retirement without noticing a significant reduction in your take-home pay. Over time, this can help you reach the 15% target contribution rate, while still enjoying some of the benefits of your raise.

Important Considerations Before Contributing More to Super

While investing in super offers advantages, it’s essential to consider how it aligns with your overall financial situation and goals.

Other Financial Goals:
If you’re paying off a home loan, managing other debts, or have short-term financial goals (like buying a car or funding education), consider prioritising these before locking funds away in super. It’s crucial to have a balanced approach.
Emergency Savings:
Building an emergency fund should be a priority before contributing extra to super. Having liquid savings gives you financial flexibility and security in case of unexpected expenses.
Need for Access Before 60:
Super contributions are generally preserved until you reach retirement age. If you may need access to funds sooner, look at other savings options in addition to super contributions.

Conclusion: Should You Add More to Super?

Contributing extra to super can be a valuable strategy for building a robust retirement fund and reducing taxes. However, the decision of when and how much to contribute depends on your personal circumstances. For some, especially those with high current expenses or other financial priorities, contributing extra may not be immediately feasible. For others, reaching the 15% contribution benchmark could be the foundation for a secure retirement.

Ultimately, working with a financial adviser can provide personalised guidance to help you find the right balance between super contributions and other financial goals.

FAQs

What are the main benefits if I add more to super?

The key benefits include potential tax savings on contributions, lower tax on earnings, and tax-free withdrawals in retirement. These benefits make super a tax-efficient way to save for the long term.

How much extra should I contribute to super?

Financial experts often recommend aiming for a total contribution rate of around 15%. If your employer currently contributes 11.5%, adding another 2-3% through salary sacrifice or personal contributions can help reach this target. You can do this gradually to help reduce the impact from your hip pocket.

How can I make extra contributions to super without feeling a big financial impact?

A great strategy is to increase contributions gradually. For instance, allocate a small portion of any pay raises (like 0.5-1%) to super, so the impact on your take-home pay is minimal.

Can I access my super before retirement if I need it?

Generally, super is locked until you are at least 60. There are some exceptions, like cases of severe financial hardship or permanent disability, but in most situations, super is inaccessible until retirement.

Are there limits to how much I can contribute to super each year?

Yes, concessional (pre-tax) contributions are capped at $30,000 per year (as at 2024), and non-concessional (after-tax) contributions are capped at $120,000 per year. Staying within these limits avoids additional taxes and penalties.

Should I prioritise super contributions over other financial goals?

This depends on your personal financial situation. If you have high-interest debt or limited emergency savings, it may be wise to address these first. A financial adviser can help you determine the best strategy based on your goals and needs, and whether you should add more to your super.

How To Master Your Money & Crush Your Finance Goals!

Written by dev on September 9, 2024. Posted in Financial Optimisers.

It’s time to master your money & crush your financial goals!

If you are like a lot of people we speak to, you want to master your money. If you’ve been killing it at work and moving up the ladder but your bank account isn’t feeling the same love, you are not alone! As financial advisers for young families, we hear you! It’s a common concern that despite earning a decent income, it feels like the money just slips away. But fear not, you’re not alone. In this article, we’ll explore why this happens and give you practical tips to start saving and get on track.

The High Cost of Living and Lifestyle Inflation

Living in Australia can be pricey, and young families feel the impact too. Expenses like housing, education, and healthcare can eat away at your income. Plus, as your family grows and your income increases, it’s easy to start spending more on non-essential items, leading to less savings. This is known as ‘lifestyle inflation’ – when your spending increases to match your income. As you get a promotion or raise, your wardrobe gets a makeover. You start dining out more. You go on bigger, better holidays! It’s ok to reward ourselves occasionally. The issue comes when the spending increases as much as your income.

Solution: Master the Budget Game

To combat lifestyle inflation, it’s time to create a comprehensive budget. Keep a close eye on your income and expenses, and identify where you can cut back. Prioritise saving and set up automated transfers to a separate savings account each month.

Lack of Financial Planning and Goal Setting

Without knowing what you are aiming for you will never hit your target. Figure out what you really want in life and what you need financially to make that happen. This can be anything from special holidays, to supporting family, to launching a startup.

Solution: Set Goals and Make Magic Happen

Sit down with your partner and establish specific financial goals. To start, ask yourself:

How much do you need to put aside?
When are you going to need access to the money?
What resources do you already have?

Whether it’s buying a house, building an emergency fund, or saving for your children’s education, having clear objectives will keep you motivated. Work with a financial adviser to create a tailor-made roadmap for your family’s dreams.

Insufficient Emergency Fund

Life can throw some curveballs, and unexpected expenses can derail your finances. Without an emergency fund, you might need to resort to credit cards or loans, causing debt to pile up and adding to your financial stress.

Solution: Make a Safety Net a Priority

Aim to have an emergency fund that covers three to six months’ worth of living expenses. Start small by setting aside a portion of your income each month into a separate savings account. Soon, you’ll have a safety net that brings peace of mind and guards your long-term financial health.

Not allocating where your money goes

This key step is often overlooked. Many people don’t know what is coming in or going out and this can cause huge amounts of frustration. There is an amazing way to rectify this though, without needing to keep receipts of every single thing!

Solution: Instead of just a savings and transaction account, use the bucket approach.

Allocate a percentage of your income into different accounts (‘buckets’) for different purposes. You can do this even if your income fluctuates weekly. Some bucket examples include:

Travel fund
Emergency fund
Kids
Bills & loans
Investing (shares, investment property)
Financial Freedom fund

You can then spend what you have left guilt-free because your top priorities are covered. This is called paying yourself first. It’s the number one way to make better use of your income.

The Dreaded Debt Monster

Car loans, HECS debt, credit card debt – these financial obligations can quickly gobble up your income. High-interest debts can be especially burdensome, making it harder to save for your future.

Solution: Crush Debt Like a Champion

Create a smart strategy to pay off your debts, focusing on high-interest ones first. Consider consolidating your loans or making extra payments whenever possible. Remember though – if you consolidate your loans continue to pay them off at the same rate as now, otherwise you may end up worse off! By doing so, you’ll speed up the process and free up more money to save and invest.

Retirement? It’s Never Too Early to Prepare

You might think retirement is a far-off concept when you’re raising a family and dealing with various expenses. But trust us, starting early is key to a secure financial future. Rather than thinking of it as ‘Retirement’, let’s think of it as ‘Financial Independence’, and we want to start as early as possible!

Solution: Plan for Financial Independence Starting Now

Don’t miss out on retirement savings options, like extra superannuation contributions. Contribute consistently and increase your contributions when possible. Start a separate bank account with automated payments that will go into an investment for your future as well. Start small, begin now. Compound interest is your friend, so start planning for those golden years today.

Feelings vs. Finances: Mindful Spending to the Rescue

Our emotions can sway our financial decisions. Stress, happiness, sadness, or even peer pressure can lead to impulse spending and losing sight of your goals.

Solution: Spend Mindfully and Keep Your Goals in Sight

Before making a big purchase, take a step back and think about whether it aligns with your financial priorities. Give yourself a cooling-off period for expensive items to avoid hasty decisions. Practice mindful spending habits and involve your partner in major financial choices to ensure you’re both on the same page.

Unlock the Power of Financial Knowledge

We learn a lot of things at school – money management isn’t one of them. So, when we leave school and land in the real world, the ever-present advertising and marketing hijacks us. Credit card and loan offers are being pushed and before we know it, all of our income is being used up. This is when people start living paycheck to paycheck. In all the busyness many young families overlook the importance of financial education.

Solution: Invest in Your Financial Know-how

Without knowing the ins and outs of personal finance, you could miss out on valuable opportunities to save and grow your wealth. Empower yourself and your family with financial knowledge. There is plenty of information on this topic. Make the time to learn. If needed, get solid financial advice from a professional. The more you know, the better equipped you’ll be to take control of your financial future. Your future self will thank you!

Manually managing your finances

Managing your finances manually is hard. Most people have their rent and loan payments automated, so the next step is to automate payments into your other “buckets”.

Solution: Set up automation

Automate regular payments through your online banking. Then, just check in occasionally to see your savings start to grow. The peace of mind that this brings is unbelievably powerful!

That’s a Wrap!

Gaining control of your money feels incredible! It clears your mind and creates confidence, rather than frustration or anxiety. The answer isn’t making more money, it’s about what you do with the money you have. Go forth & master your money now!

100% off everything!

Written by dev on September 6, 2024. Posted in Financial Optimisers.

Here is an idea for you. There is no such thing as a discount. There is just the price.

As we head into Christmas, many people will be lured into retailers with the promise of discounts or price reductions. Many people can’t resist the potential for a bargain – a sign promising 30% off is simply impossible to ignore!

Often, these people are giving in to a cognitive bias called
anchoring. Anchoring is where people take an initial piece of information and use it as the foundation (or the anchor) against which they assess all future information. People can’t get the first piece of information out of their head – which is why retailers publish an initial higher price before offering a ‘discount.’ The discount looks like a significant reduction in the price, and tricks a purchaser into thinking that they have bought
something cheaply.

So, if an article was ‘originally’ advertised at $100, but I bought it for $70, I walk out of the shop thinking that I have saved $30. I haven’t. I’ve just spent $70. But the retailer anchored me at a higher price.

We see anchors at work in investment markets as well. Auctioneers are notorious for it. “This property is easily worth $1 million. But we will open the bidding at $650,000. Can I have an offer of $50,000 above this?” And on it goes, with the auctioneer seeking to anchor and re-anchor people’s bidding as the auction progresses.

And then there is the sharemarket. Most people anchor their thoughts about sharemarket investments to the purchase price paid for that investment. So, if shares are purchased for $10, this becomes the anchor for all future decisions about that share. This can become a problem. For example, if the value of the shares falls to $8 while you are holding it, then the fact that you bought it for $10 is now immaterial. You need to make your decisions based on whether it is worth selling the share for $8. But most people will find it hard to ignore that selling the share for $8 will crystallise a loss of $2. Their thoughts are anchored on the $10 purchase price. Lots of people hang on to a share until they ‘get their money back.’ Unfortunately, sometimes this becomes a long wait.

This is actually another cognitive bias – loss aversion. It causes many people to hang on to shares that have fallen in value. What’s more, we often see people sell shares that have risen in value. If the $10 share rises in value to $12, then the investor can be tempted to sell and realise a $2 gain. What the investor needs to do is decide whether the share is now worth more than $12 if they keep it.

The point is the same: people need to re-anchor their thoughts about a share’s value every day they hold that share. But most people anchor a rst time and leave it at that. That’s why history shows that people tend to be too keen to sell shares that have risen in value and keep shares that have fallen in value.

So, how do you overcome anchoring? Simple: remind yourself – there is no such thing as a
discount. There is just the price that you agree to pay.

And when it comes to investing: yesterday’s losses and gains are immaterial. Today, we just have the current price and an investment’s future prospects. Assess everything against that.