Dealing With Stock Market Corrections: Ten Do’s and Don’ts

A correction is a beautiful thing, simply the flip side of a rally, big or small. Theoretically, corrections adjust equity prices to their actual value or “support levels”.  In reality, it may be easier than that.

Prices go down because of speculator reactions to expectations of news, speculator reactions to actual news, and investor profit taking.

The two former “becauses” are more potent than ever before because there is more self-directed money out there than ever before. And therein lies the core of correctional beauty!

Mutual Fund holders rarely take profits but often take losses. Additionally, the new breed of Index Fund speculators is ready for a reality check. If this brief hiccup becomes a full blown correction, new investment opportunities will be abundant.

Here’s a list of ten things to think about doing, or to avoid doing, during corrections of any magnitude:

1. Your present Asset Allocation is based upon long-term goals and objectives. Resist the urge to decrease your Equity allocation because you expect lower stock prices. That would be an attempt to time the market. Asset allocation decisions should have nothing to do with stock market expectations.

2. Take a look at the past. There has never been a correction that has not proven to be a buying opportunity, so start collecting a diverse group of Investment Grade Value Stocks as they move lower in price. I start shopping at 20% below the 52-week high water mark… the shelves are full of bargains.

3. Don’t hoard the “smart cash” you accumulated during the rally, and don’t get yourself agitated if you buy some issues too soon. There are no crystal balls, and no place for hindsight in an investment strategy. Buying too soon, and selling too soon is investing brilliance.

4. Take a look at the future; you can’t tell when the rally will resume or how long it will last. If you are buying IGVSI equities now, you will to love the next rally even more than the last… with yet another round of profits.

5. As the correction continues, buy more slowly as opposed to more quickly, and establish new positions incompletely. Hope for a short and steep decline, but prepare for a long one. There’s more to “Shop at The Gap” than meets the eye, and you should run out of cash well before the new rally begins.

6. Your use of “Smart Cash” proves the wisdom of Market Cycle Investment Management; it should be gone while the market is still falling… gets less scary  every time. So long your cash flow continues unabated, the change in market value is just scary, not income (or life) threatening.

7.  Note that your Working Capital is still growing in spite of falling market values, and examine holdings for opportunities to reduce cost basis per share or to increase yield on income Closed End Funds). Examine fundamentals and price; lean hard on your experience; don’t force the issue.

8. Identify new buying opportunities using a consistent set of rules, rally or correction. That way you will always know which of the two you are dealing with in spite of media hype and propaganda. Focus on Investment Grade Value Stocks; it’s easier, less risky, and better for your peace of mind.

9. Examine portfolio performance with your asset allocation and investment objectives in focus and in terms of market/interest rate cycles as opposed to calendar quarters and years. The Working Capital Model allows for your personal asset allocation.

Remember. too, that there is really no single index number to use for comparison purposes with a properly designed MCIM portfolio.

10.  So long as everything is “down”, there is nothing to worry about. Downgraded (or simply lazy) portfolio holdings should NOT be discarded during general or group specific weakness.  BUT, you must have the courage to cull them during rallies… also general or sector specifical (sic).

Corrections (of all types) will vary in depth and duration, and both characteristics are clearly visible only in institutional rear view mirrors. The short and deep ones are most lovable (kind of like men, I’m told); the long and slow ones are more difficult to deal with.

If you overthink the environment or overcook the research, you’ll miss the party.

Stock Market realities need to be dealt with quickly, decisively, and with zero hindsight. Because amid all of the uncertainty, there is one indisputable fact that reads equally well in either market direction:

There has never been a correction or a rally that has not succumbed to the next rally or correction..

Planning Balances Life

“Money is like gasoline during a road trip. You don’t want to run out of gas on your trip, but you’re not doing a tour of gas stations. You have to pay attention to money, but it shouldn’t be about the money.”   – Tim O’Reilly.

Road trips are not primarily about gasoline and life is not primarily about money.

There are some who find money a compelling subject and whose lives are devoted to its acquisition and retention.  Many self-made centi-millionaires had difficult childhoods and possibly the accumulation of vast wealth is in response to a deep security need.  Others play a game where money is how you keep score.  Still others are trying to become the richest person in the cemetery.

Planning improves with a complete answer to the question, “What are you trying to accomplish?”

The majority of people, the ones who hold money to be important but not the purpose of life, will be sufficiently wealthy when they have enough money to do the things they want, have enough to help others, have a margin of safety, and some left over at the end of their lives.

There are efficient ways to get “enough” money.  Vast sums normally involve greater risk, more time commitment, and lower amounts consumed in the enjoyment of the journey.  Most of us are not willing to tolerate the price to acquire great wealth.

Be careful in defining “Enough.”  Think about it in terms of the purpose of the money.  When that is clear, using only moderately complicated arithmetic you or a planner can calculate how much your “Enough number” is.  Then and only then will you choose a method to achieve it.

If you start with just a number, the problem of accumulating becomes a bit abstract and abstract is not very motivational.  When the “Enough number” means something, like live a certain way, take vacations, play golf, own a boat or cottage, educate grandchildren and provide healthcare as required, then people stick to it longer.

Plans like this take decades to accomplish.  Very few of them succeed without emotional motivation.

A more serious mistake that some people make is the mistake of choosing a method before they decide on what the method must achieve.  That tends to fail because it is even less motivating than a mere number.

A good plan deals with all aspects of life and its development.  It will provide balance among the past, the present and the future.  Some people emphasize the present at the expense of the future.  Still other emphasize the future at the expense of the present.  It is  important to know how much to save, but good objectives and methods will also tell you how much is okay to spend. The present is important, and guilt-free spending can only be accomplished when you know what is truly available.

Life planning can be smooth or bumpy, or it can fail to start entirely.  Which one is often the natural outcome of a poorly considered beginning..

 

Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. Contact: don@moneyfyi.com

Managing The Cap

Cowboys owner Jerry Jones: “Free-agency busts hindered Super Bowl chances”

Jerry’s problem is just like yours. Previous commitments limit your ability to accomplish what you would like in the future.

The headline was atop a recent Sports Illustrated story. NFL teams, like the Dallas Cowboys, are subject to a salary cap. If a high salary player does not perform up to expectations their salary still counts and there is less money for other players that might contribute. It limits flexibility and the chance to improve. Poorly managed salary cap issues have doomed the success of more than one team.

The effect is exactly the same in your household. Everyone has a budget cap. If you exceed it, you will be punished. Maybe not immediately, but soon. You reduce your flexibility and your ability to control your future when your cap space is used up by previous commitments that no longer contribute value.

Things like credit card payments for clothes or vacations or furniture. There is also the extra amount you pay to lease a high-end car instead of something more modest. Same with bigger mortgage payments on a bigger house.

When you commit to make payments in the future, you have committed part of your budget cap and that amount is no longer available for anything else. If people made explicit statements about how that worked there would be fewer problems. Something like, “If I spend this extra $400 a month for this car that I like instead of the one that would serve well, I will need to give up golf club fees to make it work.”

The more likely response is to borrow more to make the payments or to save less. Either way you are paying for the present with future dollars. Someday the future will appear and there will be too little money to pay for things that matter.

It is the old story. You can only spend a given dollar once. If you commit future dollars to payments, they are spent today even though they may not come out of your bank account for a while.

jerry-jones-1024x856Financial planning is about balancing the present with the future. Part of the present is paying for the past. Balancing is not an easy task and it is one that requires great discipline.

Just like Jerry Jones, though, you cannot have control of your future if you commit to things that should not have been part of your life. Flexibility is an important asset. Do not give it up easily.

Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.

Instant Success Takes a Long Time

The Beatles came to America February 7, 1964 and played the Ed Sullivan Show two nights later.  73 million people watched.  45% of all American households with a television tuned in.  Just slightly lower than the rating for the 2014 Superbowl.  For those who saw it, it is a marker on their life line.  Where were you that day?

Recent specials have given the impression that the Beatles arrived in America, were met by large crowds, sold out wherever they went, made records and movies and sold posters and toys in vast quantities.  They were suddenly famous and successful.beatles aldershot poster

The result may be true, but as with so many success stories, it hides other important things.

Few success stories start with.  “First I became famous” and theirs is not different.

I came upon this site recently.  Retronaut The Photographic Time Machine.  The link will take you to photographs taken on 9 December 1961 in Aldershot, UK.  Barely more than two years prior to the Sullivan show.

It looks like a pretty interesting event.  Price is not bad.  Bar and Buffet.  “Liverpool’s No. 1 Rock Outfit”.

Quick quiz.  How many people attended?

Would you believe 18.

Admittedly the event was not well advertised and their manager was replaced shortly afterwards.  But 18!  To see the Beatles live and up close!

beatles aldershot crowdGreat success often disguises the work involved to acquire the skill and presence that seems to have arisen by fate or an act of God.

Talent helps.  Pleasing looks, winning personality, warmth and ease with people matter and add value.  But they are not enough.

The work is what drives the other factors.  Unfulfilled potential is common.

In Germany in the early days, the Beatles often played four shows a day.  It was difficult and financially unrewarding, but they learned their craft.  In England they did gigs like Aldershot.  No limousines, no roadies, no fans even.  But they carried on.  By late 1963 they were recognizable in Europe and a few in the United States knew of them.  Then the explosion.

Every business and every career follows this path.  Doctors take nearly a decade to train.  Financial advisers are of little value early on, but if they pay attention, they become useful.  My friend Paul Racine claims that an insurance adviser needs to do 50 applications a year just for practice so that when he does the ones that matter, he is and looks competent.

Malcolm Gladwell claims that it takes 10,000 hours of focused practice to become professionally skilled at anything.  I think he might be right, but true professionalism may take even more.

In 1944, music professor, Percy C. Buck wrote “Psychology for Musicians.”  In it, he summarized the nature of the path for anyone who wants to become exceptional.  “An amateur practices until he can get it right.  A professional practices until he can’t get it wrong.”

Percy Buck made another point on the same subject.  “An amateur can be satisfied with knowing a fact; a professional must know the reason why.”  The reason is that depth of knowledge demonstrates how a thing came to be.  Depth discovers patterns and tendencies.  It fuels creativity.

There is a similar idea in mathematics.  An elegant proof is one that proves the theorem efficiently and also gives clues as to why the proof is true.

When looking to become a financial adviser, seek depth of knowledge. With depth of knowledge comes the ability to notice nuance and exceptional circumstances.  Curiosity is the engine.  An adviser should pay attention to little things and learn how they combine into big things.

If you go deep enough you will hear the sound of discovery.  Discovery always sounds the same.  You hear someone saying, “Hmm.  That’s odd.”

Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.

Volatility Can Hurt You

You cannot ignore rate of return volatility if you are projecting over long periods.  I recently saw a piece that put forward the idea that volatility costs yield if there are withdrawals during the period. 

It seems reasonable that over the long haul, volatility could not possibly help you if you were taking money out of your account.  Sort of negative dollar cost averaging.  So a test.

I have not tested all possible time scales, nor have I looked at all possible markets.  The period I tested was very long.  From 1 January 1924 to 31 December 1993.  The market is the Toronto Stock exchange as represented by the total return index.  The average rate of return, (geometric average) is a little over 10.20% and the standard deviation of annual returns is more than 18.88%.  A volatile market.

I chose an opening balance of $10,000 and made constant $500 withdrawals each year.  Over 70 years, the ending balance, with the volatility, is $3.6 million.  With a constant rate of return equal to the average, it is $4.1 million.  Volatility, therefore, cost half a million dollars.

Interesting, but not terribly useful.

What I want to know is the answer to this question, “What is the equivalent constant yield that provides the same ending amount as the volatile yields.”

Answer:  Roughly 10.02% 18 basis points less but with standard deviation of 0%.

There are two important truths.  1) You can only calculate this adjustment after the fact.  In the beginning, you merely need to be aware of it.  2) Be reluctant to count on average rates of return if the withdrawals are a high percentage of  the original capital. In this case, if the withdrawal was level and equal to the average yield, exposed to volatile markets, the portfolio would crash in the 22nd year

Using bond returns instead, we find the following.  Average yield 5.7+% with a standard deviation of  8.5+%.  Much less volatile.  However, the end balance will be negative by the end of 1973 with the same $500 withdrawal.  If instead of $500, I draw the average return each year, it will last until 1961, 37 years.  Notice.  That period is longer than equities because the volatility is less.

At a constant rate of return and $500 out, I will need to reduce the average yield by 104 basis points to get the same result as I do with volatility.  Almost a six times bigger adjustment than for equities.

The take away, is that the average yields for a given dollar amount withdrawal are more misleading when you use bonds as your underlying investment than when you use equities.  Probably balanced portfolios are somewhere in between.

For different periods, different withdrawal rates and different market choices you will get materially different answers.  When building a model of your future finances, the key element is the mix of your expected rate of return and your withdrawals.  You can use the average over long periods and expect to survive, if you draw money at less than half the expected average rate of return.  If you draw more than that, you should adjust the yield expectation downwards, possibly by a lot or shorten the period that you can do it.

Contact: don@moneyfyi.com  |  Follow Twitter   @DonShaughnessy

Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.

Price Does Not Indicate Value

bitterness of poor quality
Price, by itself, is a poor indicator of value.  Things have a lower price for a reason and the reason is that you are buying less.  If you do not know the excluded parts, there is no way to assess value

 

The result of the “price describes value” mistake is in this common wisdom, often forgotten.  Everyone should know it by now.

Best known for his work as an art critic and social critic, Englishman John Ruskin, expressed it clearly 175 years ago.  Nothing has changed since.

Its unwise to pay too much, but its also unwise to pay too little.  When you pay too much, you lose a little money ….. that is all.  When you pay too little, you sometimes lose everything because the thing you bought was incapable of doing the thing it was bought to do.   The Common Law of business balance prohibits paying a little and getting a lot … it can’t be done. If you deal with the lowest bidder, it is well to add something for the risk you run, and if you do that, you will have enough to pay for something better.

The essential point is this.  Cost is what you pay and value is what you get.

Price is one part of cost, but not the only part.  As Ruskin points out, the risk of loss because of an absent aspect is another part of cost.  What could be taken away?   Durability, support after sale, ease of use, difficulty in maintaining, or any of a hundred other things.  Maybe it was stolen.

For example, Renewable Term 10 life insurance is about the lowest priced form that there is.  The reason is two-fold.  People who can pass a medical are nearly certain to live 10 years.  If they live more than 10 years and their health deteriorates in the interim, the price of the renewal will be high enough that the insurance company is okay.  They are saying to themselves, “Anyone who keeps this policy at this price, knows something about their health that we do not and that thing is adverse.”  If they had no problems they would just do a medical and buy new again.  You give up the right to keep the insurance at a reasonable price.

All life insurance costs the same.  It is the package that changes the price.  For more premium, you get more value.  For less, you get less.

Furniture is another category where the “price is not value” rule applies.  Good furniture is not cheap and cheap furniture is not good.

Before you make a decision based solely on price, notice this idea, also from Ruskin.

There is hardly anything in the world that some man cannot make a little worse and sell a little cheaper, and  people who consider price only are this man’s lawful prey.

Being prey rarely ends well.

Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.

Money and Teenagers

What does your teenager know about money and what should they know?

Success with money begins early and is a skill that grows with experience.  You need to participate to learn.  Like golf, you cannot learn it from a book or a DVD.  Books and DVDs can help but the important parts are experienced.

There are only a few things that are important.

  1. Money is value that a person receives in exchange for some other value they gave up.  Wages are in exchange for effort and time.  Interest is in exchange for waiting to use the money.  Profit is the return for investing and providing skill, time and effort.
  2. Money is the method that allows the time of earning and the time of spending to be different.  A $20 bill in a drawer will buy something another day and waiting will not diminish it.
  3. If someone gives you money, they are essentially giving you some past effort that they have made.  There is no free money.
  4. Governments want to spend money and they have none of their own and no way to earn any.  They need to take it from the people.  All government money is the people’s money first.  A citizen should notice that it would work better if the government spent less or at least spend what they take wisely.  Be aware of governments.  They will likely be your single larges expense.
  5. There is a difference between earning money and getting money.  People can get money in many ways.  Gambling is one, albeit unevenly profitable.  Reorganizing the capital in a publicly traded business is another.  Packaging and unpackaging assets is another.  Remember mortgage backed securities.  The most insidious “get money” deal is credit cards.  Few ads show the pain of getting out of credit card debt.  The pain of payments and the cost of interest lasts much longer than the joy of dinner.
  6. Money is time and skill and effort.  Sometimes spending makes sense if they think about it in terms of hours instead of money.  Is a video game worth five hours of working at a menial job with people who don’t treat you very well?
  7. Don’t spend all your money as you receive it.   If you do then you can never save and you cannot repay a debt without reducing your lifestyle.  Most people do not like reducing lifestyle.  Better to not start by spending all your money.
  8. You can only spend a given dollar once.  You cannot have your cake and eat it too.  When you decide to spend a dollar on something, it automatically means that you choose to not spend it on anything else.  Pay attention to what you have decided to exclude.  It is very easy to miss that the dollar you spend today was actually committed to be spent later for something more important.  In simple terms, you cannot buy hockey tickets today with tomorrow’s gas money and still expect to get to work.

Teenagers need money in order to learn what it is for and how it works.  Ideally regular income for required work.  Be sure they have enough to make some stupid mistakes.  Advances are okay but they must be repaid from reduced future income.  Do not bail them out when they do make mistakes.  They need to learn that once the money is gone, it is gone forever.  The only way to pay off a debt or to save capital is to reduce  lifestyle.  They will learn this lesson eventually, better they learn it when they are 17 than when they are 32.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.

Intuitively Obvious Is Usually Wrong

It has been my experience that when I receive summarized data and there is an obviously right conclusion, I should worry.  My rule is that when something is intuitively obvious, it is likely wrong.  I find that it usually pays to be a skeptic with summarized, and especially averaged, data.  Here’s why.

People have intuitive belief systems that are incomplete and the incompleteness provides a source of error.  Worse it is outside their knowledge so they cannot analyze it effectively.

For example, if I tell you that product X has an average approval rating of 7 out of 10, what does that mean to you?  Probably pretty good.  At least average satisfaction.  Okay to own it.

Let’s see.

The population of all those who rated the item gives it an average rating of 7, but the 7 does not tell us anything about the population who rated it.  We fill in that information by assuming the ratings are normally (bell curve) distributed.  What if they are not?  Suppose out of 100 people, 70 rated it 10 and 30 rated it 0.  A U-shaped curve.  The average is still 7 but it means nothing.  You would need to know the characteristics of each group of raters before you could decide if the item is satisfactory in your context.

Mistrust averages.

Using statistical information intuitively tends to create policy errors with both individuals and governments.  It is remarkably common in social policies.

Suppose I tell you that at the University of California Berkley, the grad school discriminates against females.  As proof, I offer the information that of 1,835 women who applied to graduate school 30% were admitted, while in the same period, of 2,590 males who applied, 46% were admitted.  Should the government intervene with quotas to make the acceptance rate more equal?  Pretty clear, right.  Assuming you agree with the intervention idea at all.

Actually not so much.  You do not have enough information to make the assessment.  The part you are missing is the answer to a question  “To which programs did they apply?”  Grad school is an amalgam of many programs and they don’t have the same characteristics.  You assumed equality of base information.   When the breakdown is known, the answer becomes more clear.

         Males       Females
Program Apply Admit Apply Admit
A       825       512 62% 108        89 82%
B       560       353 63% 25        17 68%
C       325       120 37% 593      202 34%
D       417       138 33% 375      131 35%
E       191         53 28% 393        94 24%
F       272         16 6% 341        24 7%
 Total    2,590    1,192 46% 1,835 557 30%

Now we see that in four out of six programs females were more likely to be admitted than males and in the other two programs, it was close.  In any program where more males applied, the female acceptance rate was higher.

Here’s is where it gets interesting.  For programs C,D,E, and F there were 327 of 1,205 males admitted and 451 of 1,702 females.  24% each.

The key to the puzzle is in the relative number of applicants.  In programs with a high acceptance rate A and B, there were not many females who applied.  In programs with lower acceptance rates females outnumbered males.

The conclusion is not that Berkley grad school discriminates against females but rather that the programs females prefer at Berkley have inherently lower acceptance rates.  A quota system would not fix that.  Expanding the facilities for programs C,D,E, and F might.

The data is drawn from Wikipedia and P.J. Bickel, E.A. Hammel and J.W. O’Connell (1975). “Sex Bias in Graduate Admissions: Data From Berkeley”. Science 187 (4175): 398–404. doi:10.1126/science.187.4175.398. PMID 17835295.

I wonder how many quotas are based on faulty but intuitively obvious data?

When you see a summary like this, you are seeing an average of averages.  Always a misleading item.  You cannot average averages unless all the components are identical in population size.

Statistical information looks intuitive but it usually is not.  Our minds are made for simpler things.  It is a bit like compound interest in that you need to work it out to get the real underlying ideas.

In your financial planning, be very cautious with average yield or average inflation rate especially over a long time.  The averages do not mean what you think they mean.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.

A Sane Article About Investment Fees

There has been much commentary on transparent investment fees in the past several months. This one in the Globe & Mail by Preet Banarjee is excellent.

Financial industry needs more transparency on fees

Preet makes several good points. For example, some advisers and fund providers are perhaps not worth what they receive and unbundling would mitigate that.

He also points out that most people do not notice the cost and they should. Partly right, but without a comparison to what happens with no fees that may be a red herring.

People need to know the fees so they can make decisions about whether the value received is reasonable given the price paid. I agree conditionally. If clients knew value then that would work. Thus the red herring above.

After unbundling, the result will be these:

  • Advisers who do not provide excellent value will be dismissed.
  • Clients with large investment balances may pay less.
  • Some, maybe many, people will do it on their own.

I find none of these to be offensive. What is troubling are the other reasonable outcomes.

  • Small balance accounts will be unable to use skilled advisers because their income potential will be too little to justify the work involved. That outcome is quite clear and well documented in the UK.
  • The non-perceptive investors think no fees means no cost. They will discover that the costs are still there, just packaged differently. They will lose both money and time.

Here’s where those hidden costs are found. Each must be replaced in the do it yourself model.

  1. Fund managers get about 0.75% on average for deciding on and executing trades, maintaining custody of assets, reporting, research and structuring the offerings. Index funds cost little while some specialized funds are much more.
  2. Dealers supervise advisers and perform other services. Compliance reviews, marketing support, training, technical support like tax questions, planning, development tools, and handout material for clients. Usually about 0.35%.
  3. Adviser share is typically between .75% and .95%. For that the client gets a person to talk to who is familiar with the goals, limits, and risk tolerance. The client gets a plan, implementation and regular follow-up. Most importantly the adviser is the client’s conscience. Most financial success is not found in yield, it is found in starting and sticking to a plan of saving for a very long time. Few individuals can do that on their own.
  4. The last part is about .25% and that is for HST. I don’t know what you get for that.

If an investor decides to go it alone, upstream fees and costs will be as much or more. Individuals have little leverage so economies of scale will be absent. Structures like tax efficient funds and the ability to balance from cash flow instead of sale and purchase will be unavailable entirely. Balanced portfolios will require continuing attention.

Opportunity cost is real. Better to spend your time as an excellent businessperson, physician, dentist, teacher or engineer than the same time spent in becoming a mediocre investor.

Supervision, planning services, technical support and focused reading material will be unavailable as there is no dealer in the no fee structure.

HST will go away, as will its value.

The great loss for many will be the adviser. Advisers help you now; probably in ways you don’t notice. A balanced approach is about more than adjusting the portfolio. Your adviser should balance you. Knowledge, motivation, impulsivity, risk, patience, discipline.

Paying fees may turn out cheaper than paying nothing.

That’s it. It comes down to value. Good advisers are worth more and weak advisers are worth less. It is the same with dealers and fund managers. If transparent fees clarify that, then let’s get to it.

I suppose there will be someone to look after the person who is starting out and has $10,000 saved. I just don’t know who that will be. Maybe banks. For the ones that think they can get something for nothing, good luck to them.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.

 

Are More Choices Good For You?

More choice equals more freedom, therefore “Good!” seems like the self-evident answer.  As with all other self-evident answers, this one is wrong. That wrong result has significant impacts on financial advisers and on their clients. Reality is that the more choices you have the more dissatisfied you will be, and the more dissatisfied you are the more changes you will make, and the more changes you make the poorer will be your outcome. And you will make the changes even when the outcomes are good enough, even very good.

Consider my friend Eugene. He is a super-organized master of detail. Many years ago, in July of that year, he paid off the mortgage on his home and as the result had money to invest each month. His investment vehicle of choice was a Registered Retirement Savings Plan, (RRSP) which would give him both savings and a tax advantage. But which one?

Being super organized, he prepared a spreadsheet. (Actually a lot of large paper sheets taped together on the dining-room table with inked columns and rows.) Each column was a possible RRSP plan and each row was a characteristic of that plan. The detail in each box he derived from an almost infinite number of brochures that he acquired from every bank, trust company, credit union, insurance company, stock broker and fraternal organization that he could find.

It was to be a supremely rational decision, but choices impaired rather than helped.

As the end of February deadline approached, he became more frustrated. According to his wife, at one point there were 174 plans in the matrix. What should he do? What did he do?

He made an excellent choice. He took the money he had set aside and they went to Hawaii for two weeks.

Why was that a good choice? Because it did not deal with the RRSP decision.

By having many choices, he guaranteed eventual dissatisfaction. No matter how good his first choice might have been he would have found in a year or two that there was a better one he should have made. Dissatisfaction leads to weak decisions in future. By choosing Hawaii he avoided the choice/dissatisfaction problem.

Eventually he accepted “good enough to get what I want” as a reasonable option.

For advisers, offering many options seems like a good idea. It makes you look impartial. Pick what you like, I can do it. But it does not work. You are the expert, the client is the one who knows the least technically so why should they make the decision.

If a doctor treating you for serious disease #7 said, “There are four choices for treatment. Here are the risks and probable outcomes for each, which do you want?” you would be appalled. You would likely say, “Which do you think is best?” or, “If you were me, which would you choose?” You would not be accepting of, “But I am not you and you need to decide.”

Marketing folks believe that clients value choice, it is a part of their differentiation approach. The evidence, from author and professor Barry Schwartz, is that while clients value choices, they don’t want to make them and when they pick from many they tend to be more dissatisfied with the outcome. That makes for poorer client relations.

When there are fewer choices, people expect less. There is room for a pleasant surprise. Today, with all the choices, people expect too much and are dissatisfied when it does not appear.

How do you manage expectations and performance successfully when perfect is the minimum?

Make recommendations. Accept some responsibility. Do not try to dump the decision risk to the unknowing client. If you are concerned about the liability find another client. One who gets it.

No matter the choice someone makes, it will never be the best one. It does not need to be the best. It merely needs to be good enough to reach the goal.

Decide that “good enough” easily implemented and easily monitored for management and easily monitored for connection to your plan is what gives you freedom.

More choice increases risk because it expands the reasons for dissatisfaction. (With a lot of choice there is an implicit opportunity cost.) When dissatisfied, you change something. Change hurts outcomes because change costs and so you cannot afford to do it very often. By having more choices, your risk of loss increases even if all the choices are good ones.

When you think about it, how badly served would you be if you put all your money into a balanced portfolio with a manager who had a decent record. They study the market and select investments. They reallocate to keep the predetermined ratios. You do little other than check to see if they are still investing as you expected them to do and supply the capital.

I have never checked to see if an average, or a little above, balanced fund is the answer but my instinct is that over a long time, I would be ahead both money and satisfaction.

The best satisfier is getting what you want.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.