When the complacent CEO gets hacked

By Terry Cutler

When that home phone rings at a time of morning when sleep has moved into deep R.E.M., and the text messages start appearing it could only mean one thing to a CEO; there is a problem with the company security net. This could cost millions.

From best-case scenario to worse, you go over it in your head. Best Case? The security team caught a small breach. It isn’t enough to be overly alarmed, but it does warrant a phone call. Worse? Your monitoring system has spotted what security is calling “highly” suspicious activity over the company network. They are addressing the problem.

When the phone is answered you are told it is the ladder and the situation is expected to get worse.

This could mean even bigger money problems. Nasdaq, Sony, Citibank, whos hacks cost millions. Citibank’s hack attack (http://moneywatch.bnet.com/saving-money/blog/devil-details/citi-hack-attack-6-things-you-must-do-now/4769/) in June of 2011 exposed personal information about some 200,000 customers. Since 2005, some 533 million personal records have been exposed, according to the Privacy Clearing House (https://www.privacyrights.org/). Sony’s 2011 hack of its PlayStation now reports that up to 70 million people had their personal data in jeopardy to hackers after a breach in 2011. Sony’s cleanup was estimated at 2 billion dollars.

In the meantime, the overnight customer service representative is reporting more than the usual complaints of unauthorized debits to their credit cards and banks, and your customer service department is overloaded with irate customers.

You’re next move? Admit it: you’ve been hacked.

Three credit card companies are on hold. Enough, you say. You’ve known all along, and on your way to work, the longest drive of your life. The year 2011 has been called the year of the hack, or at least more companies are admitting their security had been breached. Time to minimize the damage. On the drive to the office, you order company representatives to post a notification letter on the website, explaining the situation and assuring customers that the company is working on the problem. Offer credit-rebuilding services and flag unauthorized use of credit cards, and offer free stuff.

As CEO, you are aware of the value of reassuring customers and keeping them as valued customers. It’s the company’s bread and butter. A company’s reputation if founded on how customers are treated, and including them in the problem through notifications will help maintain the established reputation. Your head security consultant meets you at the door. He informs you that the hack is not as bad as first thought. In fact, only a few files were lifted, but the network was breached, and the consultant reminds you that security is not a reactive game, but one with a proactive approach.

What he is saying is budget more money for security – it’s better that way. Or pay the price of a large-scale hack!

The decision is clear, or is it?

Next week: why companies don’t budget for an eventual hack

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So What Goes in a Full Financial Plan Part 3 of 3

So – now the wrap up of this series.

Financial Planning is intensely personal and clients need to have complete faith and trust in their advisor to make the process work properly, effectively and efficiently. The relationship is the key to success.

It is for this reason, that top planners spend the first meeting just working on laying the foundation for a relationship to grow and blossom – listening is the key of course – the good Lord gave us two ears and one mouth – and good planners and advisors use them in that ratio! This is what as known as a “non-interview”.

I first learned about this concept about three decades ago by reading a book by a fellow named J. Douglas Edwards – “Questions are your answer” – copies are still available in used book stores and on-line – I highly recommend that everyone involved in the financial/estate/retirement planning process, read it – and read it several times. In fact, it is excellent reading for anyone in a sales, marketing and/or management role.

I want to touch on the reporting now – I can hear advisors and planners already saying that if they covered everything I listed in my two previous posts, the final report is going to be 100 pages in length! Well, that depends, doesn’t it ——– on the client.

Some clients are detail-oriented, number crunchers, navel inspectors, etc. – and for those people, a planner can create dozens of reports and many dozens of pages – looks impressive I admit – but of what value to the client?

I learned from studing about and listening to people like Jim Rogers, John Savage, Jack and Gary Kinder, Norman Levine, Charlie Flowers, Don Pooley, Hal Zlotnik, Rick Forchuk, Dick Kuriger, Jim Otar and many others – that simple is best.

In my experience, I have found that the planners who use the longest reports are often trying to impress clients with quantity as opposed to quality. Certainly the attitiudes of the client drive the entire process – including the reporting and some clients do want more details than others – but this is a fine line to follow.

I have found that there needs to be enough detail to illustrate to the client that their goals can be achieved given a certain set of circumstances, what changes they need to make and actions they need to take and I allow the client to determine how that is done. As an example, before I present a plan, it is my normal practice to ask them a few questions first, including: How much time to you want to spend at our next meeting reviewing the plans? Do you want to go over the entire plan in detail, or do you want just a high-level summary and then decide on what sequence to follow before getting deeply involved in the entire report? As part of my interview process, I ask clients very early on to indicate their priorities in dealing with their goals – and regardless of my personal preference or prejudice, I follow the sequence or timing as verbalised by the client – this is critical IMHO.

My preference is to give a high-level overview at the first reporting meeting – typically no more than 3 or 4 pages – I don’t want to frighten them or have them start to think they can’t change anything – spoon feeding in other words. Then the rest is covered over the next two or even three meetings so they aren’t overwhelmed and I use LOTS of pictures and graphs and as few tables of numbers as possible. If they ask for some specific details, of course I can produce them, but I don’t try to bury them.

Last, but not least, as a professional financial planner, it is great to have a plan but unless it is implemented and there is regular follow-up (at a minimum of once every two years) to make adjustments as necessary – the whole thing collapses into a pile of snot with only some wasted money and good intentions left lying on the ground!

Anyway, that wraps up this series – hope you find some of the comments of value or at least thought-provoking – agreement is neither necessary, required or expected! Cheers Ian

Taxation and financial planning – Part 2 of 2

So let’s pick up where we left off last week.

Whether people recognise it or not, wealthy people do pay more total taxes than lower income earners – they like more toys, more vacations, more luxuries – guess what – there are taxes included in all of those items too – but then, to admit that would go against the current 1% versus the 99% protests! The simple fact is, there is no “tax freedom” day – everything we spend goes for taxes or raw materials – everything in between is taxes or becomes taxes in one form or another – but let’s not get depressed about it! How does this impact on financial and insurance/estate planning?

Projecting future tax rates that might apply to retirement income or tax credits that might exist for personal health care is a losing proposition. The same applies to the future impact of estate succession/capital gains or even inheritance taxes (which will come back in the future in one form or another – guaranteed!)

Most software programs in use today around the world for the financial services industry, add compelling statements such as “full income tax T-1 calculation done for each year of your plan” (pardon the Canadian influence – but I are one – and proud of it!!). What rubbish. The only thing that COULD accurately be said is the tax calculations are reasonably accurate for the PREVIOUS tax year – everything else is at best an estimate and at worst, a SWAG.

Canadians want more services paid for by “governments” so the governments have to get more $$ from the tax payers to pay for those services. Remember, there is only ONE taxpayer – that is each person. Businesses don’t actually pay any tax – never have and never will – they are simply conduits to get taxes from tax payers to the various levels of government. Some politicos say we are going to raise taxes on various businesses – how nonsensical! Does anyone seriously believe that the business is going to reduce profits to owners, partners and shareholders to pay the tax? Of course not – they just increase the cost of the item, good or service they sell to…….guess who……. tax payers!! But then, that isn’t nice to admit either! The same applies when businesses are charged royalties for accessing natural resources – the cost of those royalties are simply passed along to the consumer – who is also the tax payer – again! BOHICA!

In financial and insurance/estate planning, all we currently need to address are income taxes – and then only as a best estimate. It is my normal practice to include a large disclaimer relating to tax estimates and then I go further by increasing the projected costs by a further 10%. Why do I do that? I have never met a retiree in need of health care who complained about having too much money available to get the level and quality of care they want. I have never met a widow or widower or orphan or surviving business partner who ever complained about having too much tax-free cash available. And I know all governments are going to need more revenue in the future – and they can only get it from us!

BTW for those readers who may not be familiar with the words SWAG or BOHICA – they come from my past military experiences – SWAG – silly wild ass guess – BOHICA – bend over here it comes again! Cheers.

What happens to Average and CAGR when deposits are made every year?

So let’s go back and do the next problem in looking at averages and CAGR – as noted previously, I am going to ignore Median results as they are completely without any justifiable foundation. So here we have the same rates and sequence of returns with the only difference being the addition of $50.00 to the fund each year. As you would expect, the end result in terms of dollars is higher – no surprise.

However, check out the CAGR – IT HAS DROPPED from the 5.38% in the previous blog! Why – because there is an ever increasing amount of capital and the compounding effect of the ups and downs – particularly the downs, result in a lower overall calculated Compound Annual Rate of Growth – something that most people do not expect.

Year Rate . . . . . . .$1,000.00
1992 . . .7.8 % . . . . . .$1,131.90
1993 . . -4.6 % . . . . . .$1,127.53
1994 . . 29.0 % . . . . . .$1,519.02
1995 . . -2.5 % . . . . . .$1,529.79
1996 . .11.9 % . . . . . .$1,767.79
1997 . .25.7 % . . . . . .$2,284.96
1998 . .13.0 % . . . . . .$2,638.50
1999 . . -3.2 % . . . . . .$2,602.47
2000 . .19.7 % . . . . . .$3,175.01
2001 . . .6.2 % . . . . . .$3,424.96
2002 . .-13.9 % . . . . . .$2,991.94
2003 . .-14.0 % . . . . . .$2,616.07
2004 . . 24.3 % . . . . . .$3,313.92
2005 . . 12.5 % . . . . . .$3,784.41
2006 . . 21.9 % . . . . . .$4,674.15
2007 . . 14.5 % . . . . . .$5,409.15
2008 . . .7.2 % . . . . . .$5,852.21
2009 . .-35.0 % . . . . . .$3,836.44
2010 . . 30.7 % . . . . . .$5,079.57
2011 . .-14.4 % . . . . . .$4,390.91

Average . . .6.84 % . . . . . .$5,907.68

CAGR . . . . 5.01 % . . . . . .$4,390.91

As you can see the difference between the AVERAGE growth rate and the CAGR has now WIDENED to 1.83% – it may not seem like a lot, but in real dollar terms it is! If you re-run this table and substitute the Average Growth Rate of 6.84%, the resulting value after 20 years is $5,907.68 – a difference of $1,516.77 – or an increase of 33.5% over the actual value using the CAGR or the variable growth rates from the table. What a horrendous error rate!!

How can a potential error rate of this magnitude be justified in any financial plan – retirement, estate or any other component?? All I can suggest is that if you are going to use average rates, you will need plenty of E & O coverage within the next few years!

I am going to presume that readers are now satisfied with my statement that using historical average rates for forward-looking assumptions is a fools game – but remember, this discussion isn’t over as we have to examine the impact of inflation and then taxes – then to complicate matters I am going to compare the sequencing of returns during the both the accumulation phase and the withdrawal or decumulation phase of financial plans. More fun and games with numbers – I am going to stay with the same assumed growth rates in this table – but simply flip them end for end – and see what – if any difference this has on the end results!

Cheers

Average, Mean/Median and Compound Annual Growth Rate – what is the difference?

Greetings once again and welcome to the next discussion on these topics. I have created a small table (shown below) to illustrate the differences using a simple representative 20-year period that overlaps the market events of mid-2000 years. Charts and tables that project growth rates over long periods of time are always suspect, but we need to start somewhere. I have chosen 20 years as a period to which most people can relate. Most industry charts cover periods of 60 years and longer and show calculated results going back to day one – while interesting, I feel they are of very little value and clients find them confusing and relating to that duration is hard.

Average versus Median versus Compound Annual Growth Rate – initial investment of $1,000.00 January 1st, 1992.

1992 . . . . . . . 7.8 % $1,078.00
1993 . . . . . . .-4.6 % $1,028.41
1994 . . . . . . .29.0 % $1,326.65
1995 . . . . . . .-2.5 % $1,293.49
1996 . . . . . . .11.9 % $1,447.41
1997 . . . . . . .25.7 % $1,819.39
1998 . . . . . . .13.0 % $2,055.92
1999 . . . . . . .-3.2 % $1,990.13
2000 . . . . . . .19.7 % $2,382.18
2001 . . . . . . . .6.2 % $2,529.88
2002 . . . . . . -13.9 % $2,178.22
2003 . . . . . . -14.0 % $1,873.27
2004 . . . . . . .24.3 % $2,328.48
2005 . . . . . . .12.5 % $2,619.54
2006 . . . . . . .21.9 % $3,193.22
2007 . . . . . . .14.5 % $3,656.23
2008 . . . . . . . .7.2 % $3,919.48
2009 . . . . . . -35.0 % $2,547.66
2010 . . . . . . .30.7 % $3,329.79
2011 . . . . . . -14.4 % $2,850.30

Average . . . . .6.84 % $3,755.58

Median . . . . .9.85 % $6,546.38

CAGR . . . . . . 5.38 % $2,850.30

Total Growth Rate includes Interest, Dividend, Capital Gains and Capital Losses for a nominal portfolio based on 100% of the S&P/TSX. Rates are for illustration purposes only.

A simple average of the Annual Growth rates, results in a number of 6.84%, the median/mean is 9.85% while the actual Compound Annual Growth Rate equates to 5.38%. Please note the comments/disclaimer at the bottom of the table.

So now the question becomes, which rate do we use for financial, insurance and estate planning – assuming that the portfolio described matches the risk and KYC profile of the client.

The mean or median rate is obviously not valid as this simply means that half the returns were higher than 9.85% and half were lower – and the answer is really – so what! That leaves the average or the CAGR.

The table shows that if we use the average rate of 6.84% and compound that for the 20 years, you or your client will only have $3,755.58 – significantly MORE than the actual result of $2,850.30 using the CAGR of 5.38%. An argument can be made for using either one, but speaking personally, my comfort with higher rates has reduced over my career and I would always use the LOWER of the two numbers and would recommend this approach to both consumers and advisors. If you use the lower rate, you are unlikely to be disappointed while using the higher figure introduces a higher level of uncertainty into all calculations. I will point out – that I am not satisfied with using the 5.38% rate either as you will see in the next couple of blogs – too many uncertainties still arise – but 5.38% is at least something closer to reality that what I see being used in most financial planning scenarios, software and insurance illustrations.

This discussion is far from over – there are four other issues to discuss in future blogs: first – what about the effects of inflation on the results; second – what about the impact of income taxes; third – so far I have only looked at a single lump sum deposit – what happens with periodic deposits or withdrawals; fourth – what are the effects of reversing this illustrated sequence of results?

BTW, here is a link to a website that can do all of these financial calculations without requiring a financial calculator – I use it regularly! The S&P/TSX Total Returns I pulled from Jim Otar’s Retirement Calculator – I provide a link to his excellent website in an earlier blog. http://bing.search.sympatico.ca/?q=calculating%20rate%20of%20return&mkt=en-ca&setLang=en-CA

S (and) P/TSX INDEX VERSUS DOWJONES INDUSTRIAL AVERAGE AND LET’S ADD INFLATION!

It has been said that there are Liars, Damn Liars and Statisticians – and you can throw in Economists for good measure! Another approach is to ask a mathematician, an accountant and an actuary the result of the formula 2 plus 2 equals what? The mathematician will say 4, the accountant will say that depends (explains a lot about some financial reporting!) and the actuary will ask, what do you want it to equal? Through creative choices, numbers can be made to say just about anything a person desires, if you apply enough “logic” – no matter how flimsy!

Apples to bananas! As we explore the effects of growth rate assumptions on financial, estate and insurance planning, I am going to take a slight detour to briefly discuss two benchmarks commonly in use – the most popular being the S&P/TSX – which is an INDEX, and the DJIA which is an AVERAGE – they are NOT interchangeable nor do they measure the same things!

The DJIA measures the 30 largest (by market cap) US Corporations – subject to annual reviews and adjustments. The S&P/TSX measures (allegedly) the 300 largest (by market cap and not necessarily purely Canadian) companies trading on the TSX. At last count, there are apparently about 290 companies included in the S&P/TSX Index. Finally, one is expressed in CDN currency and the other in US currency so variations in the DJIA, as usually seen in Canada, also reflect exchange rate movements.

As you can see, the DJIA is only a very narrow “measurement” of market value and movement while the S&P/TSX is, at least in theory, a reflection of a much broader market. Very different measurements yet for some reason they are entwined as being very similar, if not identical – and not just by the media, many in the financial services industry are also guilty of this “grouping” for comparison purposes.

The closest US market measurement to the S&P/TSX Index is the S&P 500 Index – as the name implies, measuring the movement of the largest 500 US Companies – also in US Currency and then converted to CDN $ for use here – again adding exchange rate movements to the changing index values.

Many people are unaware that we (Canadians) do have a “large cap” index that is SIMILAR, but not identical to the DJIA – it is the TSX60 – which measures the 60 largest companies trading in Toronto. So, if comparisons about movements, trends, etc. are to be made, it is certainly far more appropriate to compare movements (net of currency exchange effects), between the DJIA and the TSX60. Other major exchanges around the world also have narrower, large cap sub-indices similar to the TSX 60.

For more specific information about the compositions of the various indices and market averages, please refer to their specific websites – or have fun with Wikipedia.

Inflation has been around since someone started to track changes in prices of various goods and services. In Canada, we use the Consumer Price Index as measured by Statistics Canada. All details can be found on their website plus additional information on Wikipedia. Obviously, the basket of “goods and services” in use today is very different than 50 years ago – even 20 years ago – consumer choices and options change – therefore so does the “basket”. In Canada, inflation is separated into a “full measure” of everything and then a variety of sub-indices such as “core” inflation along with others such Health Care, Education, Recreation, etc.

Comparisons between inflation rates amongst various countries is close to impossible – each country is measuring different items, then of course, we may have currency issues that could also affect published rates – check the websites for each country to determine how currency may impact published results.

All too often, people in our industry and in some cases the media, tend to use a single inflation assumption in our planning – which is patently incorrect. When people retire, the effects of inflation are typically higher due to probable higher costs for Health Care and Recreation, while some aspects of the total inflation rate will drop such as business transportation.

I will discuss inflation in planning in more detail in a future blog – my only purpose here is to caution people to be careful about your chosen basis for assumptions during different phases of the planning process – different rates for education costs, health care, recreation, housing, etc. are all appropriate – a single presumption is not!

BTW, I watch Business News Network each morning to catch Marty, Frances and Michael plus their various guests – plus I regularly use their website – www.bnn.ca – for other updates and information on various indices – including the TSX60.

So – average interest and growth rates – are they realistic or do they create misunderstandings for both clients and advisors?

Ever since I was a lad (yes, that long ago), all calculations for determining amounts of insurance, how fast savings and investments grew and how retirement income rates were deterimined, have used “average” rates of return – not even median rates – just average rates. And for about 100 years or so, people seeemed happy with that approach until the 1970s and 80s came along with rampant inflation, outlandish rates of return and then a wonderful market “correction” in the latter part of 1987.

No-one knew quite what to do, but a couple of smart young men came up with the idea to put this all on a chart so people could at least examine history – in one place – and hopefully make some better choices and assumptions while planning for their futures – and the ANDEX (copyright) chart was born! I loved it immediately (lots of pretty coloured lines and graphics too – I am easily amused)! Fortunately for our industry and our clients, this chart is not just still available, it has been expanded and updated to include even more useful information under the Morningstar banner (and no, I don’t get any compensation for saying this!

These charts (and other following competitor versions) also included the “average” rates of return for the various market segments for various time periods. While interesting to see the changes over time, I feel these “averages” actually took away from the validity of the material – which was to show that segments of the markets move randomly and that while “average” projections were interesting, they weren’t overly valuable for making long-term projections. These charts also provided all of the necessary proof that GICs and savings bonds were neither adequate on their own and that in order for a client to enjoy any reasonable probability of achieving their goals, other assets and products had to be considered.

Having received a great amount of both theoretical and experiencial education in this phenomenon, I have come to the conclusion – despite having been guilty (along with the rest of our industry) of using average growth rates in everything from growth in universal life policies, estimating future values for investments and planning for both retirement and estate distributions – sometimes 40 years into the future – this practice is now foolhardy in the extreme!

Stay tuned for the next collection of wandering thoughts as I explore this further using some actual numbers!

Welcome to my bog and some random thoughts!

As the newst blogger here, I would like to say that I am looking forward to sharing some thoughts and opinions (most of which are politically correct but some aren’t!) that will challenge a lot of conventional wisdom within the financial community and the industry at large. I welcome comments (pro and con) as well as suggestions for future commentary.

For my next blog, I will offer some opinions on “traditional” financial planning using average interest/growth rate assumptions and the move along to Monte Carlo simulations – are they really a major improvement? If anyone wants a “sneak preview” on those thoughts, I refer you to Jim Otar’s excellent website as noted under TAGS. As a follow-on, I next plan to look at what a reasonable rate (if you must use a fixed rate), makes sense and will stand the test of time!

Remember, I did say I was going to challenge some long-held beliefes and principals – to get us all thinking about how we work with our clients and their future plans!

Cheers Boom Boom