The KISS Method Revisited

Keep It Simple Stupid (The KISS Method) is usually good advice.  However, some things are complicated to start with so the “keep it simple” option does not exist.

Then you need the MISS method.  Make it simple stupid.  There is a limit to this however.  Einstein is quoted as saying that you should make a thing as simple as possible, but not simpler.

Find and focus on the essentials.  For financial planning, things like debt management, savings of all kinds, insurance, wills, powers of attorney, a margin for error, and flexibility.

Financial planning is an area that possesses more than its fair share of complexity.  Much of it driven by the unknowable future but still a good portion driven by unknowing clients and their sometimes misdirected financial planners.  It is not as easy as you think.  Spend time promoting client literacy.  It pays.

If you, the client, are to be successful, you will need to know more than you do now and you will need to condition your expectations to the real world environment.  Earn 15% forever?  The fellow who can do that for you is down the hall – second door on the left, just past the flying pigs.

Planners.  Stow the arrogance.  Sure, it is fun to have 75 page financial plans.  Some of them are at least internally consistent, but no one pays attention.  You are preparing the plan to help the client not to impress another planner with its elegance.

Besides, in most cases, the assumptions matter more than the substance, but the client does not know that.  There is almost no chance that the client can make decisions based on what is there.  These plans exist only to condition clients to accept your recommendations.  In the long run, you will be blamed if it does not work out.  People do not accept responsibility well and certainly not when they did not understand the decision.  Ask any lawyer.

Some financial plans I see remind me of Finagles Fourth Law of Experiment:

“Build no mechanism simply if a way can be found to make it complex and wonderful”

Financial planning matters too much to go the complex route, especially in today’s unforgiving financial environment.  Let’s try to get people to focus on the fundamentals.

  • You cannot borrow your way out of debt.
  • You cannot spend more than you earn for very long.
  • You cannot invest what you have not yet saved.
  • You cannot avoid risk, but you can minimize it.
  • You cannot continue to overlook boring financial products that solve problems.  (RRSPs are not as much fun as movie limited partnership interests)
  • You cannot miss the fact that your children are a financial liability for a long time.  So is your eventual retirement.
  • Taxes matter.  Do you have a TFSA yet?

What would be wrong with going back to old ways?  Have a long term direction, an intermediate term plan and an annual budget.  Be frugal.  There will likely come a time when more sophisticated methods will apply, but not before the basics have been solved.

If you have a problem, find a process that solves it, implement it and carry on.

Better a set of simple and complete steps than a sophisticated structure that may not cover all the ground.   Certainly better if than if client cannot tell what to do when some underlying assumption changes.

If the client cannot tell what they should do this month and why, then they do not understand their plan.

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.  don.s@protectorsgroup.com

CAPITALISM HAS A DARK SIDE

By; Don Shaughnessy
Capitalism is very fair. Ruthlessly so. In its purest form, you receive value in proportion to how society values your contribution. Your reward depends on what people will buy and at what price.
Is it fair that baseball players make more than philosophers or rock musicians make more than engineers? Yes! People in the aggregate of society are willing to give up more of their wealth to enjoy the contributions of rock musicians and baseball players. They are satisfying themselves not some arbitrary idea of what should be valuable.
Although you would be hard pressed to learn this from politicians, capitalism is not a political philosophy. It is a method of allocating the resources available to society. Each of us makes many small decisions and those aggregate to the result we see. Jimi Hendrix music earns more than Mozart music. If you want to change that, you need to change all of us, or as some people believe, use political power to make things work out “right.”
It is unlikely that we can agree on “right” but the end result of legislating it is that some people get something for nothing and others get nothing for something. Not necessarily a bad thing, some of us need assistance, but it is not perfect when the result requires bureaucratic helpers.
A bureaucracy cannot solve a problem. To do so would mean extinguishing itself. Never assign a problem to someone who will be personally harmed if they are successful. A bureaucracy grows by making the problem it purportedly solves bigger, more subtle and harder to measure. Ideally for the bureaucracy, impossible to measure.
This reallocation of resources to bureaucracies is unnatural, so it will not work forever. The dark side of capitalism is always there.
The dark side, destroys misdirected wealth.  That means, in the absence of political intervention, misplaced assets or assets in incompetent hands, are removed. In the fall of 2008 and early 2009 we saw the efficiency of capitalism. Economist Joseph Schumpeter talked about “creative destruction.” Addition by subtraction.
Compare that to socialism.
Socialism has no failure mechanism. Things go on as long as there is political support. Since there is no process to reposition capital through small failures, there can be only eventual catastrophic failure. Think the Soviet Union in 1989. Rather like forest fires. If you prevent or kill the small ones, you guarantee a big one.
Instead of examining the past several years and trumpeting the “Failure of Capitalism,” intelligent observers should be trumpeting the success of the dark side of capitalism. you cannot ignore that things that don’t work, don’t last. And should not last.
If our society is to prosper, it will be because we choose to direct excess wealth to growth not to wasteful regulation and inept problem solving.

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.  don.s@protectorsgroup.com

What Shape Is Your ORG Chart?

By: Don Shaughnessy
If you expect to sell your business one day, the shape of your ORG chart will matter. The wrong shape is not salable at all.
In classic organizational theory an organization chart shows how different functional positions relate to one another and how they communicate. It is a simple way to describe how decision making, responsibility, and authority is allocated.
Many are hierarchical. Think of the Catholic Church or the army. It is like a pyramid. As you go up, there is more authority and responsibility. The decisions become strategic. Lower levels are responsible for methods of implementing the strategy and the doing of day-to-day deeds.
Sometimes an entity, (more likely part of it) can have a matrix form. In these, skilled people report to their pool manager but also to others who are in charge of a particular project. Software engineers frequently work in this form
Lastly, there is the flat organization, where all the people are closely involved in decision making. It works when the communication network allows it, but this form tends to go away as the entity grows. It becomes too difficult to see the overall picture from every position within the organization.
Many family-owned businesses have another structure. If you draw it out, it looks like a garden rake instead of a triangle.
In your business, does only one person:
• Know the goals of the business?
• Know most of the important information?
• Make most of the decisions, (important or otherwise)?
• Provide leadership?
• Control customer, employee and supplier relationships?
• Provide financing or guarantee support for loans?
If yes, that person is like the handle of the rake.
Notice that removing the handle will have the same effect on the business as it would have on the rake. Make it useless or at best ridiculously inefficient.  You cannot sell that.
If you want to be able to leave some day, build middle management and insure your life and health against the possibility that the handle could fall out prematurely.
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.  don.s@protectorsgroup.com

Hotrods, Lear Jets and Hospitals

By: Don Shaughnessy

What do drag race cars, Lear Jets, and potentially hospitals, have in common?

If you ask hotrod drivers what is the most important thing, they will say, “Go fast in a straight line.”  Every other choice for vehicle construction is made inferior to that.  Comfort is not even considered to be a worthy thought.

Before developing the Lear Jet in the ‘60’s, William Lear observed something interesting.  After two hours in the air, passengers most valued “getting there.”  So, he built a hotrod executive jet.  It was not luxurious, because luxury was merely a convenience.  He focused only on the customers’ principal value – getting there sooner.  His jet was the fastest and it was the cheapest both to buy and to operate.

Focus on a single purpose may simplify healthcare issues.  Why???

Hospitals have a basic problem.  Value decisions get weird when the user of the service (patient) and the people who pay the bill (governments) are disconnected.  Users of the service, who have access to cost numbers, are the only ones who can objectively judge value.  Everyone else uses a proxy of some kind.

Without the bill, patients employ an unpredictable proxy.  Service will be seen as “good value” if staff is friendly and instantly available, or the many (maybe unneeded) tests are done quickly and effortlessly, or there is a comfortable bed in a cheery, quiet room, or the food is acceptable, and visitors are welcomed.  Probably some combination of these with unknown, or worse ever-changing, weighting of the parts.

Administrators use other proxies for value.  1) Not too much complaint from the patients, 2) Achieve budgets, and 3) Hit target wait times.

No one is doing wrong.  Boards act in the best interest of the user, while administrators act to satisfy the bill payer (government.)  Nurses, doctors and other staff try to satisfy both – a perpetually failing proposition.  All act in good faith and do as well as possible within the parameters of their jobs.  They just don’t see the same purpose.

When we see that the values of the various stakeholders are not consistent, we know the strategic vision is incomplete or wrong.

Just as with hotrods and Lear Jets, the users of the service (patients) need to answer a question.  “What do you value most?”  In a hospital, the likely answer is, “Nothing is better than getting better.”

Hospital administrators would do well to focus on that single important thing and address less attention to resource consuming conveniences that minimize complaints.  As an example, it is unacceptable to accept an increase in the number of c-difficile cases that result from reducing maintenance costs to balance the budget.

In the end, focusing on the important value makes patients happier and costs less.

 

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.  don.s@protectorsgroup.com

Investing Is Tough Stuff

By: Don Shaughnessy

Profit is a poor proxy for success and investors should not rely on the number without considering other facts.
Strangely a business can become bankrupt while it is profitable. This profit ambiguity causes problems for business owners, managers, policy makers and investors.
What do you mean by profit?
Suppose an incorporated business earns $1,000,000 using the tax rules and generally accepted accounting principles (GAAP) In Ontario, the tax bill would be $220,000 leaving $780,000 to invest. Clearly profitable!
BUT, only within the system of GAAP and taxation. In the real world, the result might well be very different.
Suppose the business must invest $1,500,000 to remain competitive in its industry, (same market share and same technology as the leaders in the industry.) Did it really make a profit or did it really lose $720,000?
The economic answer is it lost $720,000, and even that is not simple.
By investing the profits and borrowing, the business continues to exist and possibly a weak entrant in the industry will become weaker still and succumb. So the true long-term economic loss is actually somewhat smaller. Maybe a lot smaller and possibly not a loss at all. Some of the cash loss is an investment in future market share.
Management faces the task of deciding if they will survive long enough to benefit. Especially true if the government bails out the weak ones.
For those looking at profit alone, other expenses matter too. Marketing, advertising, R&D, employee training and more, pay off over long periods but have immediate cost. Good for tax expense but hard for the analysts to validate. Some other expenses, like pensions, have a visible price today but an unknowable future cost.
In both accounting and taxation, profit is not the result of facts but rather is the result of rules and opinions. Things like depreciation rate, inventory and product obsolescence, bad debts, investment rate to be earned on the pension fund, future technology effects and more.
As an investor, is there anything at all to be gleaned from the financial statements?
Maybe.
In most cases, it makes sense to pay attention to the management letter. I know a high performance fund manager who looks for the words challenge or challenging in that letter. If he sees either he throws the statement away. In his words, “I have only limited resources, so why would I invest with people who have challenges?”
When looking for an investment, use commons sense first. I like the product, I like management, I like the industry and so on. Then look at the numbers.
• “Cash is real, profit is opinion.” Or at least cash is more likely to be real because you go to jail if you fool with it. Not so much with profit.
• Look for dividends. They impose a discipline on management and the cash paid out reduces the homeless dollar problem. When management finds that problem, some pretty dodgy projects get funded.
• When things go wrong, quit quick. Holding losers and waiting for recovery is a losing tactic. The price of tulip bulbs, which peaked in Holland in February 1637, has, as yet, not returned to that high.
Good look!
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.  don.s@protectorsgroup.com

What’s The Greedy Algorithm?

Many people instinctively use a greedy algorithm to solve problems, but they should have no expectation that it will generate optimal or even good results.

By: Don Shaughnessy

Back in the depths of history, I took a course in operations research.  Essentially the process of applying mathematical analysis to real world problems.  One of the interesting parts was the Greedy Algorithm.  It is the process where you choose the most expedient next step without consideration of other possible solutions or even how you got to where you are.

Some (even most) possible courses of action can thus never be implemented because the first step is not as good.  The greedy algorithm can perpetuate or even create problems.

For those with short time frames, it’s attractive.  “We are going to do this now and we will deal with any problems that arise, if and when they arise.”  Bias to action.  Sometimes they say it even when the future problem is known and certain to occur.

Micromanaging is an indicator.  You can make all the decisions if you only think one step at a time.

The algorithm can sometimes generate the unique, worst-possible, answer.  The “traveling salesman” problem where you are to find the best way to visit a list of customers is one. Take the closest next seems obvious, but that choice will always generate the worst route.

When the algorithm fails, it is because an early right looking step was wrong.  People tend not to go back and restart.  Often that choice is unavailable.  Lovers of greedy usually attack the newly observed problem in isolation and again use the greedy algorithm to solve it.

That’s debilitating.  Partly solved problems become chronic.  There are only a few problems (matroid, if you care) where you get an optimal answer being greedy.  Worse yet, using the greedy algorithm denies you the ability to learn.  Because the breakdown appears later, you only learn to avoid that step and there may have been nothing wrong with it.  Nothing tells you to stop using the failure inducing first step.

A financial plan evolves over a long period.  You should not watch the next step too carefully because it can take you away from the overall strategy that you need.  Worse still, most of the good early steps are boring.

A mistake is your friend, but only if you learn something of value from it.  In this case Gordon Gecko was wrong.  Greed is not good.

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.  don.s@protectorsgroup.com

Smoking Costs How Much?!!

By: Don Shaughnessy

Fundamentally, the world is a fair place.  The more you smoke, the less time you are required to do it.  Maybe a good thing too, because your potential retirement fund will be harmed.

Here’s an example.  Suppose:

  • You are a 30 year old male smoker in otherwise good health.
  • You earn about $75,000 per year and have a family.
  • You have determined that your financial situation would require life insurance of $1,000,000 to resolve if you died.
  • You expect that problem will go away by the time the children are grown.  Call it 20 years.
  • You buy 20 year term life insurance.
  • You think of yourself as a moderate smoker – about 100 cigarettes a week.
  • You invest in a balanced portfolio and expect to earn 2.50% over the inflation rate, and you think it will be 3%.
  • You would and could invest in an RRSP if you had extra money.

If you cancel the insurance after 20 years and quit smoking the same day your RRSP will be short $530,552.87 at age 65.

If you did not quit smoking when you cancelled the insurance, it would be short by $747,840.09.

It is truly unpleasant if inflation is 4% instead of 3% – $1,037,790.70 short if you smoke to 65.

The cigarettes are the big piece, but the insurance is not insignificant.  $1,000,000 of 20 year term costs $140.40 per month for a smoker and $74.70 for a non-smoker.  A non-smoker who is 42 would pay $141.30 for the same million.  They are trying to tell you something here.

The lost capital because of the insurance price difference, even if you cancel, is about $90,000 in the 3% inflation example.

If you decide to keep the insurance longer than 20 years, at renewal it costs $1,440 per month versus $700 for a non-smoker.  Many people have a fatal heart attack when they see the price of renewal so maybe that is not really an issue.

Everyone’s situation is different, so your mileage may differ.  But the general direction is clear.  To stop smoking is not fun, but it should be considered.

Personally, I liked smoking.  I quit in Scarborough, on Tuesday, June 25, 1985 at 1:55 in the afternoon, not that I’m counting.  I have not had even one cigarette since.  I still miss it a little but not as often.

Sadly I didn’t put the money away.

Maybe you can be both smart enough to stop smoking and smart enough to put the money away too.

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.  don.s@protectorsgroup.com

I Cannot Afford Anything That Cheap

By: Don Shaughnessy
Intuitively, price and cost are the same thing. Very wrong! Catastrophic mistake in the making! Truth is you get value by incurring cost and the money is just part of it.
Suppose you are flying over the prairies and the captain comes on the intercom and declares that the plane is going to crash. Fortunately, the airline has made provision for this and will rent parachutes to those who want them.
An attendant comes to you and says, “We have two kinds. One is $50, the other $100. Which do you want?”
You know that price is a poor way to judge value, so ask, “What’s the difference?”
“The $50 ones are factory seconds and work about half the time.”
The value, escape from a failed airplane, cannot be adequately achieved with the $50 parachute. Its cost to you is the money of $50 plus the acceptance of a 50% probability of death. The alternative of $100 and no concern for blood stains on the ground looks like a better deal.
Just like life insurance.
From the insurance company’s perspective, all life insurance “costs” the same. People die at the same rate regardless of who insures them or how, the cost to do business is about the same for all carriers and the investment returns they receive don’t vary much. If a carrier can offer a lower price, it is because they put something in that you don’t want, or took out something you do want.
An insurer could sell for half price if the contract included a clause that provided that in the event of a claim, the insurer will toss a coin. Heads they pay. Tails not. Some policies almost have this provision. It is the pre-existing condition clause. With it, you can’t be sure you have coverage.
An insurer would offer a very attractive price if you agree to take a medical every year and the policy ends if the company doesn’t like the result. How much is the access to coverage worth to you? You must pay more money to replace the cost of uncertainty.
Consider English philosopher, John Ruskin’s view.
“There is hardly anything that some man cannot make a little worse and sell a little cheaper, and people who consider price alone are this man’s lawful prey.”
If you don’t know how the price difference arises, you are blindly accepting a cost that is as real as money. Invisible is not the same as not there. I cannot afford anything that cheap is a thought to consider.

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.  don.s@protectorsgroup.com

Maybe The Mayans Are Right

By: Don Shaughnessy

How would you behave if you knew with certainty that the world would end next week?

One of the people I went to university with is a big-time political operative. He once told me that even when the government is doing things that look stupid, they know more than we do and if we knew all, their actions would make sense.

I have come to believe he is right and our viewing point is too narrow to encompass all the conflicting interests in the country and the world. I am even more firmly convinced that the Americans know more than anyone else because they work at it more.

With the idea that the government always knows enough to make their positions and policies make sense, I have tried to analyze the fiscal position of the United States federal government. (It could as easily be California, Ontario or almost any other.) At first glance it is irrational.

But, I can explain it. I have decided that they know the Mayans are right and the world will end in December 2012.

Knowing that makes their policy make sense because there could be nothing dumber than to have the world end while you have an unused line of credit. Think about it. If you knew, with certainty, that the world would end next Tuesday, do you think that a few nice dinners might appear on the VISA card. I think so. Possibly a room in the presidential suite at the Four Seasons too. I might even miss a tax installment.

So it is with them. We think they are dumb and are trying to borrow themselves out of debt. Not so. They know they will never be required to pay the money back, so no need to be concerned about incurring more debt. Live for the moment.

I wonder how they know and I wonder if I should follow the same course they do.

If anyone knows how they know, please be in touch. I would even accept any other logical explanation for their fiscal policies. The downside if the Mayans are wrong is ugly; so, thus far, I am not brave enough to implement the plan.

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.  don.s@protectorsgroup.com

The 1% Solution

By: Don Shaughnessy

Vilfredo Federico Damaso Pareto was an Italian Renaissance man born 250 years too late. He was an engineer, an industrialist, a philosopher, a sociologist and best known as the first modern economist. He is the one who noticed the 80-20 rule. The Pareto Principle.

It would be hard to find someone who has not heard of Pareto. 20% of the effort gets 80% of the results. Focus on key customers, key markets, key products, key processes. Focus will make you rich. Might be true, but all that focus causes you to miss another important aspect of the principle.

The Pareto Principle is a power law. That means that you can go further. If 80% results from 20% of the effort, then 80% of the 80% resulted from 20% of 20% of the effort. The 64-4 result. The third is 51.2% for 0.8% of the effort. More follow but the point is clear. There are only a few things that really matter.

51% of the result for 1% of the effort is a nice deal, but, there is a lot of clutter to toss before you can see how.

You start by thinking about where the 1% may or may not be.

It won’t be in filling out forms for the government or collecting receivables. Planning a better parking lot or counting inventory won’t help much either.

Cost analysis, automation, engineering and marketing are worth looking at but might not include the 1%.

The 1% most probably is in freeing time to do only those things that you are the best at doing. It is not enough that you are the best, it must be your best best.

You might be the best salesman in the room but you are only that by a narrow margin. You may be the best customer relations person or the best inventor or the best leader by a much wider margin. Let the others carry the ball where they can do nearly as good a job and spend your time on the things that may include the 1%

Sweet reward here! Employees will like it and do better than before.

People who have searched for the 1% found important things:

If you have no idea of what the 1% might be, you could stop doing it by
accident.
It is not the same 1% all the time and in every situation.
Your employees know and will do more than you think. Let employees be
creative and helpful.
Customers know the difference between price and value. Deliver value.
Customers know how they will be changing in future, ask them.
Customers know what they don’t like. Ask them and listen.

Looking for the 1% works. No one ever finds it, but finding a little of it is a big win.
Start Now!

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.  don.s@protectorsgroup.com