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Trusts
The Right Scenario
By William Kaufman
Branch Manager, Raymond James Financial Services, Inc.
Could it be that some of the traits that help
people become wildly successful are the same
ones that cause difficulty later on?. I have
observed successful business people focus their
efforts and talents relentlessly in one direction
and rarely look back for fear of losing their lead.
When they fail they pick themselves up,
evaluate how and why they went astray, and try
again.
These people have learned to first concentrate
relatively few available resources on a project
and than leverage them like a breeder reactor.
“Concentrate” is a key word here. Discovering
and fully using freely available resources in a
way that large competitors have not, doing one
or two things really well, adding one innovation
to a widely used system, perfecting a single
strategy faster and better than anyone else, all
are examples of their ability to focus resources
and do the “one best thing” with what little they
have.
Ask them how they became successful, and
they will usually be able to answer in several
short sentences. They "happened" on the right
formula, approach, strategy, and product; that
is, they happened to do the “one best thing” with
what little they started with.
Odd as it may seem, this writer has noticed that
when it comes to family financial planning, these
otherwise successful people frequently find
themselves at an impasse.
The paradox is that the best financial planning
often requires the obverse approach of what
helped these same individuals achieve success.
Rather than a single strategy or approach, the
best financial plans are usually multifaceted
constructs aimed at avoiding risk, maximizing
return, minimizing taxes and securing loved
ones. Each component of such a plan
complements the others and creates
redundancies insuring against failure. They are
not "one best thing" affairs.
What one hands down as a result of his life's
work is going to be measured by how well he
does many good things with money during this
period. There is a transition here: making money
doing the one (or two) best things in business,
keeping it doing the numerous right things as
an investor and family leader. The transition from
executive, business owner, entrepreneur, to
investor and family financial planner, involves
some serious brain rewiring.
Absent the rewiring, the most common solution
has always been to do generally one thing with
one's money, and the one that is generally
considered the safest thing. The most common
approach is to buy risk free short term treasury
bills or triple-A short term municipal bonds. This
is a comfortable way to deal with perceived risk,
and, of course, it parallels the “one best thing”
syndrome. But any “one thing” strategy
introduces un-noticed risks into a portfolio and
one, for example, is inflation risk. What if our
national currency loses value in the world
market and/or we have a sudden and ongoing
bout of inflation?
Another common solution is to do something
"familiar" with one's money, or just leave it alone
in it's already familiar place. That is, if in the
hustle and bustle of running one's business one
just had enough time to stash money in a safe
place like a CD at the local bank, why not just
leave it there and even buy more CDs. This "one
thing" strategy introduces an enormous risk to
self and loved ones, called “opportunity cost
risk.” As an example of opportunity cost,
compound out the loss of 300 basis points (3%)
(the approximate difference between a “risk-free
yield” today of 5%, with 8%, reasonable
expectation of long term return in a diversified
portfolio) on a $1,000,000 investment over 40
years.
[The difference is $7,086,000 vs $21,663,000!
The "one thing" safe investment created a loss
to self and family of $14,577,000!]
Whatever "one-thing" investment strategy one
adapts, with no exceptions, has a fatal flaw lying
in wait. Any one investment strategy involving
acquiring the one best asset/investment cannot
survive every scenario that can emerge in our
ever more rapidly changing eco-political
universe. Again even the “safest” investments
guarantee the lowest return and therefore the
highest exposure to at least two sorts of risk;
the loss of future purchasing power and the
“payment” of enormous opportunity costs.
But of all the drawbacks of "one-best-thing"
thinking there is one that renders even the
smartest people paralyzed with doubt. Looking
for the “one-best-thing” (which as a fiction can't
exist) makes one think a really long time to
decide on a course of action. Since look as one
might, it can't be found, the impulse is not to
act.
Not only is inaction the result, but the
Decision making process for really important
family matters becomes fraught with anxiety.
This observer believes that this is one of the
primary causes for procrastination in doing
what ever is truly in one's overall best interest.
For an investing solution to counteract one's
own tendency to fall into this trap, It may be
helpful to think in terms of portfolio construction
rather than think about acquiring investment
assets piecemeal. One might think of
investment asset groups where it isn't possible
in one's imagination to envision a scenario
where all group members all go bust simultaneously while he,
or his family, physically survives the scenario.
Using this powerful concept (which I call
scenario diversification) makes portfolio
construction engaging.
While one can't protect one's entire investment portfolio
from every conceivable scenario, obviously, not all
scenarios can emerge at once. Many are
actually mutually exclusive. While one can
always imagine a scenario that will “wipe out”
some investments, one doesn't want to be able
to imagine a single scenario that will wipe out
all, or most, or a substantial part, of one's
portfolio. If you can indeed imagine such a scenario, than you
you must make changes in your portfolio as soon as possible.
Scenario diversification is easy to
adapt- we were all blessed at birth with sufficient
imagination to adapt this powerful diversification
strategy.
By the way, If one can imagine a scenario in
which the world truly ends, it doesn't count in
this exercise because losing all our money
wouldn't matter.
Modern portfolio theory is another good starting
point. In simple terms, the major theme, asset
allocation, involves finding investments that are
inversely correlated, that is assets that don't all
go down (or up) at the same time, and that each
have historical growth rates which beat inflation
and taxes. Notice that these two concepts
(asset allocation and scenario diversification)
totally avoid the “one best thing” trap.
Its helpful to think in terms of multiple financial
planning strategies and redundancy. When one
investigates an investment for example, one
might subject it an over riding primary single
question: How does this investment complement
my portfolio?
The "one best thing" approach might subject it to
a single criteria test like: "what is the best
investment if I don't want to lose any money?"
The problem is : If one constructed most of
one's portfolio with this single criteria and then
used this same criteria to decide on future
investments, at the end of the day one would
have an undiversified (read: vulnerable) and low
yielding portfolio indeed. Little chance here of
beating inflation and taxes, of making a big
inter-generational impact, of having an ample
retirement cushion.
While one does his due diligence, he should
keep in mind that the primary question is not
about if he is "comfortable" with an investment
because one will tend to be only comfortable
with the familiar assets that one already has too much
of, and his risk grows that these similar
investments might all respond in a like manner
to any one adverse scenario.
One might think about doing the right things
instead of the one best thing. Surely the skills
that one acquired as the business owner,
entrepreneur, high paid executive, will really help
one do his financial planning, but it is really
essential to be fully aware of old emotional
baggage that may overshadow rational
thought.
Because estate planning differs from investing in
that it seems remote and esoteric, a useful
approach is to think of it as a multifaceted task
in which desired outcomes are being created.
The goal is essentially the same as investing.
And as such, the thinking process is parallel.
Good investing keeps and grows money as good
estate planning does the same, but results are
measured inter-generationally. On envisioning an
estate outcome one truly desires it is important
to realize that the results one seeks might need
to be created with sophisticated (and even
arcane) legal technology.
Surely there is no one perfect estate plan for
everyone alike, nor can there be one thing we do
that defines and insures all our investment
goals. Increasing security for loved ones,
increasing inheritable assets, reducing taxes,
and avoiding inheritor conflicts and troubles is,
however, a goal that may inspire one to accept
some initial complexity in one's planning. It's a
goal that can't be reached by procrastination
and maintaining the status quo.
We need to start looking for right things to do as
early as possible. Check out our web site for
some ideas of what other people are doing now!
We need to keep doing the right things instead
of looking for the one-best killer thing that
dispenses with the whole problem.
It doesn't exist.
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