Appendix 1: The Investment Spectrum

Individual investors typically have a range of motivations and objectives when deploying their funds. These include financial, personal and social considerations.

Many investors are committed to family businesses or property investments. In family businesses the financial and personal objectives may be closely aligned. Typically, investments in family businesses come with a significant personal time commitment either at a management or board level. Similarly, private equity investments, depending on the nature of the investment, may come with a personal time commitment in support of management. In these cases, the objectives are often not purely financial. Individuals are generally focused on achieving a commercial objective which includes both delivering on the vison or mission of the business and delivering a satisfactory financial return. Where investors have significant residential and property portfolios these investment may come with significant personal and social responsibilities. For many family businesses and property owners working with their local community is also an important dimension of their activities. In all the financial, personal and social are closely linked.

When investing in the public markets personal commitment is less important. In this case the investment spectrum spans the range of opportunity from investing where financial returns are the priority to Investing where social outcomes are the goal. Each of the various investment approaches has a particular attitude to risk and return and to its approach to Environmental, Social and Governance (ESG) considerations. There are potentially significant trade-offs between the various options.

One is in relation to risk and return where investors must consider the range of choices spanning from seeking to:

• Achieve optimum balance between risk and return

• Balance financial returns with social outcomes

• Focus on social outcomes with financial returns secondary

• Focus solely on social outcomes

A second is in relation to ESG considerations and this can be broken down further into:

• ESG not considered usually described as an Agnostic or Conventional approach)

• ESG factors considered as they impact the investment i.e. an Input Approach usually described as Stewardship & ESG Integration.

• ESG factors considered as they impact society - this is an Outcome or Consequences approach usually described as Sustainability Approach & Exclusions.

• Maximising social outcomes (Philanthropy)

Which approach is appropriate for you will be influenced by your personal circumstances and preferences and your stage in your investment journey:

• If you are seeking to build your savings and investments, then your focus may be on optimising financial returns and an Agnostic or Input approach may be appropriate.

• If you have sufficient funds for your requirements, you may wish to take a more balanced approach to social and financial objectives and an Outcome approach might suit.

• If your assets are concentrated in a family business or property you may wish to balance your existing personal and social commitments with a balanced approach.

• Where your funds are surplus to your personal requirements and you are planning to pass on your assets to the next generation you may wish to consider the Consequences approach. This can be a useful way to educate and engage your children around the opportunities and responsibilities that come with managing your wealth.

• Philanthropy can be incorporated into each approach if appropriate.

The various options are summarised in the graphic below:

In relation to risk and return, both Agnostic and ESG Integration are designed to achieve an optimum balance between risk and return. They put financial return first without consideration of environmental or social outcomes. In this context ESG factors are taken into account when trying to assess the risk adjusted returns of a company. To the extent that they do not impact on risk and return they can be ignored. This is sometimes referred to as the “Input” approach.

Sustainability Focus & Exclusions, Impact and Philanthropy on the other hand consider financial return only after ESG factors have been taken into account and the investors’ social objectives have been satisfied. In this context ESG factors are considered for their impact on the environment or society. The ESG factors may have a positive or negative impact. Negative ESG impacts considered as “externalities” i.e. costs associated with the company’s activities but currently borne by society. In these approaches the investor seeks to avoid investment with negative externalities arising from ESG factors and invest in companies with positive ESG attributes. This is what most people consider as ‘green” or “ethical” or “sustainable “investing.

We refer to all forms of investing that adopt the Input, Outcome or Consequences approach as Sustainable Investing. Most investors have minimal knowledge of the actual companies in which their funds are invested. However, when presented with a viable alternative many investors would choose to invest differently. In our experience investors are becoming increasingly conscious of the social and environmental impact of all economic activity. These investors want to see their values reflected in the companies in which they invest.

We endeavour to align your values with your investment portfolio. The right approach for you will depend on both your financial and social and environmental goals. We will explain the trade-offs between financial risk and return and ESG factors for your portfolio.

The difference between the various forms of both Conventional and Sustainable investing is explored below.

Conventional (Agnostic) Investing

Conventional or agnostic investing is focuses on maximising financial returns.

Market Portfolio

Investing in the market portfolio is often referred to as an “agnostic” or passive approach to investing. You are investing in all available assets in proportion to their market capitalisation. This is regarded as an “efficient” approach to investing. It is based on the proposition that the collective wisdom of all investors is captured in the prevailing market prices and in the absence of superior knowledge it is extremely difficult to out-guess the market.

Factor Portfolio

Under “Modern Portfolio Theory” in Appendix 5 we discuss a number of priced economic risk “factors” which have been discovered by researchers to have different risk and reward profiles to that of the market. Factor investing involves tilting your portfolio away from the market to increase exposure to one or more of these factors. This is a way to customise your investments to your risk and reward preference or employment circumstances.

For example, if you work for a Large US Tech Company you might wish to retain stock options in your employer. To improve diversification of your overall wealth you might wish to increase your exposure to smaller cyclical companies in your pension, rather than buying a passive market portfolio which could include a large position in your employer’s company. This would be a good reason to arrange a stand-alone PRSA for Additional Voluntary Contributions (AVCs) rather than saving in the main scheme.

Sustainable Investing

Historically, a multitude of terms have been used to describe investing that incorporates social, environmental, and ethical considerations along with pure financial considerations. Everlake incorporates the business of Ethical Financial which was established in 1997 with the objective of offering socially responsible investment solutions. We are committed to our Ethical heritage. In the meantime, terminology has evolved.

We now use the term Sustainable Investing as our preferred term for investing that:

• Focuses on long-term returns through consideration of pertinent ESG risks & opportunities

• Achieves sustainability outcomes (for example investing in renewable energy)

• Reflects a particular set of values or beliefs

While there are many forms of Sustainable Investing, we think it is useful to categorise them into three general categories: Stewardship & ESG Integration, Sustainability Focus and Exclusions and Impact Investing

Stewardship & ESG Integration

“Stewardship is the responsible allocation, management and oversight of capital to create long-term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society” 9

ESG refers to the Environmental, Social and Governance characteristics of a company or business. The facets of the business contribute to the risks and opportunities it is exposed to now and in the future. ESG integration is “The systematic and explicit inclusion of material ESG factors into investment analysis andinvestment decisions”.10

ESG Integration does not prohibit any specific investments as long as material ESG risks are identified and taken into account as part of the investment decision.

Sustainability Focus and Exclusions.

“Investment approaches that select and include investments on the basis of their fulfilling certain sustainability criteria and/or delivering on specific and measurable sustainability outcomes). Investmentsarechosenonthebasisoftheireconomicactivities(whattheyproduce/whatservicesthey deliver) andontheirbusiness conduct (howthey deliver their products andservices).”11

Exclusions (also referred to as negative screening) is the predominant approach of many ethical funds. There are many different types of exclusion including:

• Ethical/values-based/religious (e.g., alcohol, firearms, tobacco)

• Norms-based (e.g., companies involved in human rights violations / corruption)

• Poor sustainability (e.g., oil companies)

• ESG assessment (e.g., worst rated ESG companies)

Impact Investing

Impact investing represents “Investingmadewiththeintentiontogeneratepositive,measurablesocial and environmental impact alongside a financial return.”12 Impact investments intentionally contribute to social and environmental solutions. This differentiates

9 According to the Financial Reporting Council in the UK Stewardship Code 2020.

10 As defined by UN PRI.

11 Adapted by IA from Global Sustainable Investment Alliance (GSIA) definitions.

12 Global Impact Investing Network (GIIN) them from other strategies such as ESG integration, stewardship and exclusions. Often one of the positive impacts sought will be one of the UN’s Sustainable Development Goals.

Philanthropy

Many people are motivated by the desire to promote the welfare of others, expressed especially by the generous donation of time and money to good causes. This can be facilitated by means of ongoing support or as part of a legacy.

Appendix 2: Risk Considerations

Your Attitude to Investment Risk

While we can do a great deal to mitigate risk, we cannot eliminate it. In any investment plan, it is important to understand both the types and the amount of risk you are taking and to be sure that you are comfortable with these. This understanding will greatly increase your ability to adhere to your long-term investment plan and increase your chances of achieving your financial goals.

The right level of risk for you depends on both your personal preferences and your situation. We break the risk equation into the following parts:

Risk tolerance: Your response to market fluctuations

Over the course of your investment life, the value of your portfolio will rise and fall. While we would always rather see our portfolio value rise, a prudent investor knows that any investment will have some periods in which the value will fall. Equity and commodity markets can be very volatile, and investors must expect that there will be regular periods of rising prices and regular periods of falling prices.

Your risk tolerance describes your level of comfort in waiting through the downturns. If the risk you take is within your risk tolerance, then you will be able to maintain your investment strategy through both strong markets and weak ones, giving you the best chance of investment success.

Risk capacity: Your vulnerability to suffering losses

Designing an appropriate investment strategy requires understanding and weighing factors that can be in conflict. Your tolerance for risk may be high, but as a prudent investor, you should consider your ability to withstand financial losses. Because market downturns are unpredictable, you need to assess the real economic harm you might face if your portfolio seriously declined in value. If your portfolio failed to provide the returns you had planned for, would you need to adjust your goals?

Risk avoidance: Your need to take investment risk

Most investors would not choose to take more risk than is necessary. While this is a simple statement, investors often fail to build this concept into their investment planning. Your need to take risk is directly tied to your rate-of-return objective.

If you need your portfolio to grow more quickly over your time horizon, you will want a higher rate of return. An increase in your rate-of-return objective, however, will generally mean taking more risk. If your return objective is higher than your risk tolerance (willingness to take risk) or your risk aversion (your vulnerability to losses), then you must adjust one or more of these parameters. This could mean, for example, retiring later and possibly subjecting yourself to the discomfort of greater risk or increasing the amount that you save.

On the other hand, if your rate-of-return objective can be lowered because your assets can support your goals with less growth, then your need to take risk is reduced and your portfolio should be allocated accordingly. As your portfolio grows over time, your need to take risk should be reassessed and your investment strategy adjusted accordingly.

Your tolerance for tracking error: ability to have a different portfolio to popular indices

Many investors are more comfortable when they know they are doing as well, or as poorly, as most other investors. A portfolio that tracks the returns of a popular index such as the ISEQ can provide that comfort, despite the fact that it may not provide the risk management or higher returns that may be available from an effectively diversified portfolio.

Tracking error is the amount by which the performance of a portfolio differs from that of familiar market indices. You should understand your personal tolerance for the tracking error that can result from a portfolio that purposely diversifies away from popular indices in order to decrease volatility and increase expected returns.

Bear in mind that tracking error can be present over lengthy periods. If, for example, your portfolio is weighted heavily toward smaller companies and value asset classes because of the higher expected return over time, it will often look quite different from say the S&P 500 or FTSE 100 indices, which are composed primarily of large growth stocks. The difference can be either positive or negative and may be present over many years.

Your Rate-of-Return Objective

Every investment choice you make involves a trade-off between risk and expected return. In general, a portfolio of safer investments will have less growth potential than a riskier one. To increase the rateof-return objective, you will typically have to take more risk. Thus, your rate-of-return objective must match the realistic opportunities that you have, given your time horizon and ability to take risk. If your rate-of-return objective is higher than your time horizon and risk attitude permit, then you must adjust one of the three parameters.

All other things being equal, you would most likely prefer to have a higher return. In particular, if two portfolios were equally risky, but one made a higher rate-of-return objective feasible, then you would choose the more rewarding portfolio. One way to construct a rate-of-return objective is to find the portfolio that offers the highest possible rate-of-return objective for your time horizon and risk attitude. In the language of the academic study of investments, this is an efficient portfolio.

Over a long investment horizon, a modest increase in your rate of return can make a significant difference in the amount you accumulate. The table below shows the sum to which an initial investment of €1 million will grow over 10 and 20 years at rates of return ranging from 2 percent to 10 percent.13

One way in which investors can increase their rate of return is by keeping costs and taxes down.

Appendix 3: Tax Considerations

In desiging your investment portfolio, it is important to consider both Irish and International tax impacts. Within Ireland Investment Returns are subject to different tax regimes depending on the form of the investment. As a retail investor you generally have the option of investing in investment funds or directly in securities

• Investment Funds – means collective investment funds of any type including, Irish Unit Linked Funds, Unit Trusts, Open Ended Investment Companies (OEICs), SICAVs, UCITS or Exchange Traded Funds which are liable to exit tax at a rate of 41% (Tax year 2022).

• Securities – means listed shares, certain non-EU ETFs or certain UK Investment Trusts (which are listed companies) or any instrument (exchange traded or otherwise) that is not taxed as a fund.

Taxation of Investment Funds (Exit Tax)

Investment funds are subject to an Exit Tax of 41% (2022). This is applicable on dividends arising from the fund or on the sale or redemption of units / shares in the fund. It also applies to the increase in value of the fund after each eight year holding period.

Some of the disadvantages of this tax are

• Losses on one fund cannot be offset against gains on a different fund

• Investors pay a flat rate of tax with no allowances or reliefs and with no reference to their personal marginal rates of income tax.

• Losses on shares, property or other assets cannot be offset against gains on funds and vice versa

• A notional tax charge is applied every 8 years on notional gains whether these are realised or not

• Exit tax will apply on death

Taxation of Securities (Income Tax and Capital Gains Tax)

Taxed under general tax principles, income is subject to Income Tax at your marginal rate (plus PRSI and USC) and growth at Capital Gains Tax 33% (Tax year 2022)

Taxation implications for investors

Marginalratetaxpayers

For taxpayers with income in excess of the standard rate band i.e. those whose income is sufficient to push them into the marginal rate of income tax of 40%, then any additional dividend income from securities will be taxed at the following marginal rates of tax:

Aged 70+ with income below €60,000

For older married taxpayers the annual income tax exemption is €36,000pa and the maximum rate of USC is 2% with no liability to PRSI:

€36,000)

Standardratetaxpayers

For taxpayers with income at or below the standard rate band, i.e. those whose income is insufficient to push them into the marginal rate of income tax of 40%, then any additional dividend income from securities will be taxed at the following marginal rates of tax:

Charge (Assuming income in excess of €21,296)

14 55% if self-employed with income in excess of €100,000 per year.

15 Note a tax credit is given for Dividend Withholding Tax payable in say, the USA of 15%, making this calculation more complex in practice

16 Individuals 70 years or over whose aggregate income for the year is €60,000 or less, will only pay USC at a maximum rate of 2%. ‘Aggregate’ income for USC purposes does not include payments from the Department of Social Protection.

17 USC income up to €70,044 ignoring rate bands

International Tax Considerations

If you in invest in a international security you may be subject to the following foreign taxes:

WithholdingTax

Interest or dividends on a foreign security may be subject to withholding tax by the tax authorities where the security is issued. This withholding tax may or may not be recoverable against Irish tax. This is dependent on whether Ireland has a tax treaty with the relevant jurisdiction and what are the terms of the tax treaty.

EstateTaxes

On death international securities may be subject to estate taxes in the jurisdiction where the securities are issued. In a similar way to withholding tax the estate tax may or may not be recoverable against Irish tax. This is dependent on whether Ireland has a tax treaty with the relevant jurisdiction and what are the terms of the tax treaty

Comparison of Exit Tax and General Tax Principles

Exit Tax and CGT Portfolios

For illustrative purposes only. Assuming the investor is aged 70+ with income under €60,000pa and either has capital gains tax losses or doesn’t realise the gain during their lifetime.

Appendix 4: Asset Classes

The investible universe is divided into different asset classes. The principal asset classes are Cash, Bonds, Equities and Real Assets. Each asset class is described below:

Cash

The assets management industry’s definition of “Cash” is generally broader than many realise. As well as bank deposits, the asset class generally includes short-term debt securities such as short-term government debt, commercial paper, repurchase agreements, certificates of deposit and bills of exchange (collectively: “money market instruments”).

Bonds

Often referred to as Fixed Income, bonds are tradeable forms of loans to governments, companies, or other organisations. Bonds provide the borrower (issuer) with external funds to finance investment or expenditure. It is a debt security, under which the issuer owes the holders (creditors) a debt and, depending on the terms of the bond, is obliged to pay them interest (the coupon) and usually to repay the principal at a later date, termed the maturity. Interest is usually payable at fixed intervals (semiannual and annual being the most common). Bonds are usually used in lower and mid-risk portfolios as they exhibit lower volatility. In most cases it is crucial to hedge the currency risk on foreign bond holdings so as not to accidentally increase the low volatility profile they are selected for.

Equities

Equities generally refer to holdings of shares or stock of publicly listed companies. Equities are held in anticipation of income from dividends and capital gains, as stock prices rise. The name comes from the accounting context “shareholders’ equity” (the value of the companies’ assets after all debts are paid off). As the asset classes are most frequently organised into geographical areas and are considered the ‘growth’ assets of most portfolios. The growth comes at the cost of higher volatility than cash or bonds.

Other Assets

There are other asset classes that offer the potential for further diversification from the asset classes listed above. These include Global Property generally in the form of Real Estate Investment Trusts (REITS), Infrastructure and Commodities.

Unlike our competitors we don’t recommend Private Equity (even with the tax break of an EIS), Hedge Funds, Absolute Return Funds, Crypto currencies, precious metals, or commodity funds., structured products also known as “tracker bonds”, loan notes or any form of financial engineering which seeks to package up a product to sell something to investors in order to earn a commission.

Appendix 5: Modern Portfolio Theory

Modern portfolio theory is based on the Nobel Prize winning work of financial economists and has been developed from decades of empirical research. This approach, commonly referred to as “asset class investing”, is common within the institutional market but is rarely offered to private clients.

So, what are the differences, and why is it that asset class investing is superior and why is it not often offered to private clients?

The key difference is that the traditional stockbroker will attempt to add value by the selection and trading of stocks, while asset class investing relies upon the allocation of the portfolio to various asset classes to deliver returns.

The rationale for asset class investing is simple: capital markets work and diversification between asset classes increases return and reduces risk. Over the long run, markets reward investors with positive returns for taking risks and providing capital. If they did not, the capitalist system would have collapsed long ago. Market prices reflect the knowledge and expectations of all investors. Decades of academic research has shown that traditional managers are unable to outperform the markets by anything more that we would expect by chance. Investment experts usually summarize this evidence as a body of knowledge called “modern portfolio theory”.

The foundation of Modern Portfolio Theory was a 1952 paper, “Portfolio Selection” by Dr Harry Markowitz in which he established a theory explaining the best way for an investor to choose a portfolio. Modern Portfolio Theory is of such fundamental importance in investing that the economists that formulated the theory received the Nobel Prize in Economic Science in 1990.

Modern Portfolio Theory

has four basic premises:

1) Investors are inherently loss averse. Investors are generally more concerned with loss than they are with reward.

2) Securities markets are competitive and drawn to a long run state of equilibrium. This means that investors should assume that the price of any publicly traded security reflects the views and opinions of all market participants and is therefore probably a “fair price”.18

3) The focus of attention should be shifted away from individual securities analysis to consideration of a portfolio as a whole, predicated on the explicit risk/reward parameters and on the total portfolio objectives. The efficient allocation of capital in a portfolio to specific asset classes is far more important than selecting the individual investments.

4) For every risk level, there is an optimal combination of asset classes that will maximise returns. Portfolio diversification is not so much a function of how many individual stocks or bonds are involved, as it is of the relationship of each asset to each other asset.

18 Security prices are an “unbiased predictor” in the sense that the next move in price is just as likely to be up as it is to be down.

Following on from the foundation established by Markowitz Modern Portfolio Theory has developed into a robust body of knowledge. Subsequent work by Gene Fama and Ken French examined different characteristics of equity portfolios to determine what factors drive risk and return.

It is clear from their work that all equity portfolios are not the same. Equity portfolios can be constructed to reflect different risk & return characteristics. These characteristics are associated with a range of different investment “factors”. The main factors we consider in constructing a portfolio are size and value & growth factors.

Value & Growth

Equities or equity portfolios can be categorised as “Value” or “Growth”. Growth stocks tend to have relatively high score on metrics such as Long-term projected earnings growth, Historical earnings growth, Sales growth, Cash flow growth and Book value growth. Typically, a lot of the well-known technology stocks such as Apple will satisfy these criteria. Because of their “growth” characteristics they tend to be relatively highly valued.

Value stocks on the other hand tend to be those stocks which have a relatively low score on a range of metrics like Price-to-projected earnings, Price-to-book, Price-to-sales, Price-to-cash flow and Dividend yield. These are often more cyclical or out-of-favour businesses which from time to time will change as the fortunes of different industries such as banking, utilities or oil companies ebb and flow. However, just because they might be seen as cheaper than the market in general, does not mean that the price can’t go even lower.

Value and Growth stocks historically have a different risk & return profile. Over long-time scales Value stocks have outperformed. However there have also been sustained periods of underperformance

Size

Stocks can be categorised by size. The global names that we are all familiar with are generally largecap stocks. These will typically comprise a large proportion of the global stock market. The next tier are mid-cap stocks, and the smallest stocks are referred to as small-cap stocks. For example, in the US the top 250 stocks represent 70% of the US stock market, the next 750 stocks represent the next 20% of the market. All remaining stocks just represent 10% of the market. Each tier of stocks has a different risk & return profile. There is evidence that a portfolio of small stocks has a higher return over the longer term. This is associated with higher volatility in the shorter term.

Other Factors

In addition to size, Value and Growth there are several other factors to consider in constructing a portfolio. These factors include Quality, Momentum and Volatility.

Style Box

Style boxes are a mutual fund classification scheme created by the financial analytics firm Morningstar, which are designed to visually represent the investment characteristics of stocks and mutual funds.

Style boxes provide a graphical representation of investing categories for both fixed-income and equity investments. A style box is a valuable tool for investors to use when determining asset allocation. There are slightly different style boxes used for equity and fixed-income investments.

It is possible to graphically illustrate your portfolio positioning on a Style Box 19like that illustrated below. This is a matrix with Size on the vertical axis and Value & Growth on the horizontal axis. The style box below shows several indicative portfolios.

As you can see from the matrix most market portfolios are up and to the right reflecting the fact that the global stock indices are dominated by the large growth companies. This is true for both a conventional global market index and global ESG indices. Global equity impact portfolios tend to be in the mid-cap blend bucket although there are a wide range of options. It is also possible to construct a portfolio with a small-cap value tilt if your preference is for a portfolio with higher risk and return characteristics.

19 Style BoxTM is methodology developed by MorningstarTM to illustrate portfolios and investment funds by reference to their size and value, and growth characteristics.

Appendix 6: Behavioural Finance

Modern portfolio theory and behavioural finance represent differing schools of thought that attempt to explain investor behaviour. Perhaps the easiest way to think about their arguments and positions is to think of modern portfolio theory as how the financial markets would work in the ideal world, and to think of behavioural finance as how financial markets work in the real world. Having a solid understanding of both theory and reality can help you make better investment decisions.

Behavioural finance20 is the study of psychological influences on investors and financial markets. It uses psychology and economics to explore why people sometimes make emotional rather than logical decisions and why their behaviour does not follow the predictions of accepted economic models.

It looks for answers to questions such as why even experienced investors buy too late and sell too soon, or why someone doesn’t use their savings account to help with paying off massive credit card debt. It even studies anomalies such as the small but measurable advantage companies have in the market if their stock ticker abbreviations come first in the alphabet, or the effect of the weather on market values.

Often, our emotions prevent us from holding an optimum portfolio that will allow us to achieve the returns we need since we have certain in-built biases which prevent us from objectively constructing our portfolios. We suffer from overconfidence in our abilities as investors. We suffer from regret about decisions made in the past. We extrapolate random patterns into the future. We suffer from hindsight bias (past events now seem obvious) and we are loss averse so that we emotionally weight the benefit of gains less than the hurt of losses.

Behavioural finance attempts to identify the systematic errors and biases which recur predictably in certain circumstances, offering a framework for understanding when and how people make mistakes. There are two types of human behaviour that factor heavily in behavioural economics: heuristics and biases.

Heuristics are mental shortcuts we use to decide something quickly or not at all. Investors and financial professionals often use heuristics when analysing investment decisions. Heuristics are often based on assumptions or rules of thumb that often but not always, hold true.

20 Behavioural finance originated from the work of psychologists Daniel Kahneman and Amos Tversky and economist Robert J. Shiller in the 1970s-1980s. They applied the pervasive, deep-seeded, subconscious biases and heuristics to the way that people make financial decisions. At about the same time, finance researchers began to propose that the efficient market hypothesis, a popular theory that the stock market moves in rational, predictable ways, doesn’t always hold up under scrutiny. In reality, the markets are full of inefficiencies due to investors' flawed thinking about prices and risk. In the past decade, behavioural finance has been embraced in the academic and financial communities as a subfield of behavioural economics influenced by economic psychology. By showing how, when, and why behaviour deviates from rational expectations, behavioural finance provides a blueprint to help everyone make better, more rational decisions when it comes to their finances.

An example of a common heuristic is to assume that past investment performance indicates future returns. Although that seems to make sense on the surface, it doesn’t take into account changes in the economy, or how fully valued a stock has become. An investor might assume that because an emerging markets equity mutual fund has posted positive returns for the past five years, a sensible decision would be to maintain or increase the position in the fund. However, it is possible that the mutual fund has undergone a turnover in management, or oil prices have risen which affects shipping costs to these markets, for example. A mental shortcut in investment analysis can have an adverse effect on a portfolio.

When economic and financial heuristics lead to inaccurate judgments and beliefs, the result is cognitive biases.

The most common cognitive biases include:

• Self-attribution bias: Believing that good investment outcomes are the result of skill, and undesirable results are caused by bad luck.

• Confirmation bias: Paying close attention to information that confirms a finance or investment belief and ignoring any information that contradicts it.

• Representative bias: Believing that two things or events are more closely correlated than they really are.

• Framing bias: Reacting to a particular finance opportunity based on how it is presented.

• Anchoring bias: Letting the first price or number encountered unduly influence your opinion.

• Loss aversion: Trying to avoid a loss more than on recognizing investment gains, so that desirable investment or finance opportunities are missed.

These biases and the heuristics that helped create them can affect investor behaviour, market and trading psychology, cognitive errors, and emotional reasoning.

From an investment perspective, an important aspect of avoiding such biases is first to become aware of them. Thus, by avoiding behavioural biases investors can more readily reach impartial decisions based on available data and logical processes. This requires understanding one’s behavioural biases, resisting the tendency to engage in such behaviours, and developing and following objectively prudent investment strategies.

As investors our primary concerns are often a direct result of uncertainty about the future. We worry about the news and wonder how it might affect our investments. But we have no control over these concerns, so they make us feel uneasy. So, where should investors concentrate their efforts in order to maximise the areas where we have some control over the outcome? The simple answer is to focus on your personal goals and values rather than react to the noise from the markets.

This means identifying your personal goals and objectives, your values, and your willingness and your capacity to bear losses. Only then can we help you to determine an appropriate asset allocation strategy which should be monitored against strict tolerances and rebalanced when required. This will help guard against our behavioural biases - experienced and seasoned investors have learned that success often comes from reining in their emotions and overcoming their biases, so they often avoid making the same mistakes as many new investors. These include:

• Investor Behaviour: Overconfidence, excessive optimism, self-attribution bias, framing bias, and loss aversion often lead investors astray. All of these factors lead to irrational rather than well-considered investments.

• Trading Psychology: Trading psychology refers to the mental state and emotions of a trader that determines the success or failure of a trade. Assumption heuristics, such as making a decision based on one positive result, anchoring bias, loss aversion, and confirmation bias can yield less than desirable investment or financial outcomes.

• Market Psychology: Human economic and financial heuristics and biases affect economic markets, the odd mix of collective and independent decisions of millions of people, acting for themselves and on behalf of funds or companies. As a result, many markets are not successful for many years. Understanding what causes the anomalies in valuations of individual securities and the stock market can result in better market performance.

• Cognitive Errors: Sub-optimal financial decision-making is the result of cognitive errors, many of which are made because of heuristics and anchoring, self-attribution, and framing biases. Exploring neuroscience discoveries and the implications for financial decision-making under uncertainty can result in sounder strategies for client debiasing and financial management.

• Emotional Reasoning: Many investors believe that their heuristics and biases are examples of sound, scientific reasoning and therefore should be used for investment decisions. They are surprised to learn that they are emotional, not logical.

Disclaimer

This document has been prepared for educational and information purposes only and does not represent a specific recommendation for an individual to follow.

Taxation

References to Taxation have been obtained from sources which we believe to be reliable and are based on our understanding of Irish Tax legislation at the time of writing. We cannot guarantee its accuracy or completeness. The rates and bases of taxation may change in the future. We recommend that you obtain specific tax advice for your own personal situation. We will refer you to a suitably qualified tax consultant on request.

Investments

As with any investment strategy, there is potential for profit as well as the possibility of loss. Past experience is not necessarily a guide to future performance. The value of investments may fall or rise against investors’ interests.

Any person acting on the information contained in this document does so at their own risk. Recommendations in this document may not be suitable for all investors. Individual circumstances should be considered before a decision to invest is taken.

Income levels from investments may fluctuate. Changes in exchange rates may have an adverse effect on the value of, or income from, investments denominated in foreign currencies. We do not guarantee any minimum level of investment performance or the success of any portfolio or investment strategy. All investments involve risk and investment recommendations will not always be profitable.

Warning: the value of your investment may do down as well as up. This service may be affected by change in currency exchange rates. Past performance is not a reliable guide to future performance.

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