The Chinese ‘Fortune’ Cookie or Chinese Firecracker:
Risky Business: The Myth of “Risk Tolerance:”
Written January 6, 2015 as
the Chinese Market Takes Another Correction
It is common ground in the industry …that the task of a financial adviser is to find a portfolio that fits a number: the investor’s ‘attitude to risk.’ My purpose, here, is to suggest there is no such thing
The Myth of Risk Attitude,
Psychologists Kahneman & Tversky
Context, context, context.
A true story
Picture a geologist who, at the time, created an oil play that was the largest discovery in the lower 48.
Born in a small town in Colorado – he conceptualized the discovery sitting on some rocks at the age of 11 – that is not a misprint.
Of course, the drilling didn’t occurred until he was in his 50’s after everyone else had given up on oil being in the formation.
A wildcatter through and through.
So out of context, not considering being independent of his oil and gas revenue stream, let alone income replacement upon disability, education considerations for the kids, nor asset disposition according to desires – let alone income adequacy for his spouse should he predecease, his ‘wildcatting’ inclination permeated his ‘risk tolerance’ for investing.
But when the aforementioned goals and subsequent prioritization process occurred, it turned out -he could fund his financial independence (slow down) goal and retirement goal with less than market rates of return – given the oil income stream – becoming independent of his independent oil business.
Thus, out of context, a client’s risk tolerance inclination to his overall personal financial assets instead of relative to his prioritized personal financial life goals and values is foolishness – not personal financial planning. The perspective of a wildcatter’s investment temperament relative to business,, given the context of managing personal financial goals – modified his otherwise aggressive inclination to became quite conservative – as he reminded me with my own words ‘you don’t sacrifice what you need for what you don’t need.’ Furthermore, his measurements to be on track and accomplish his objectives were not the Dow or the S&P – but a required rate of return after tax after assumed inflation with the least risk (volatility) possible (which was lower than the historic Dow or S& P even adjusted for tax and inflation. In other cases, it may be just the opposite. The point is: personal financial life planning is contextual managing of goals not managing assets regardless of the lip service (‘have truths; whole lies’ – Talmud) of asset under management compensation by so called personal financial planners in denial. As Tom Paine said, “a long habit of doing the wrong thing often gives it the superficial appearance of being right.” (And responses of denial when challenged.)
First one needs to stop the leakages – the potential for large capital depletion (liability, inadequate income replacement from a potential disability or long term care requirement) transferring risk with contingent assets. Risk transference in these areas are the Depends™ of personal financial life planning. Secondly (really concurrently) minimize leakage (usually the imbalance of palliating niceta (aspirational / status) expenditures which compromise the gotta and oughta levels of spending. The gotta expenditure level is absolute requirements which, if not meet, would really cause anxiety – fears of the wolf at the door (lack, destitution, hardship). The oughta level is the shoulds – which would allow a comfortable without lavishness standard of living (which could jeopardize the personal financial life goals). Aspirational spending (at the expense of gottas and oughtas) can turn into ‘perspirational.’ And then neither Ban™, Right Guard™ nor Sure™ - almost for sure – won’t help at that point.
The question is ‘what is ENOUGH’ not ‘More’ (which is never ENOUGH) and just a palliative – an altered (not altar-ed) state to medicate and ironically soothe the under lying anxiety which the pursuit of More never Enough only increases – like the third carrot cake slice when complaining about the need to lose weight.
Note to those who say ‘we’ll cut back on the nicetas – the luxuries – the lavishness when and if we have to’ usually it is too late especially as one ages – and the time & energy ‘to make up deficiencies’ is shorter and shorter.
Capital depletion exposure transferred or reduced, leakages ended or minimized (“addition by subtraction”), and gotta, oughtas and niceta levels of standard living defined, then criteria may be better defined as well as acceptable percentage loses (‘risk tolerance) demarcated per prioritize objective -as well as rebalancing, accumulation – distribution strategies etc…
Trigger Personal Financial Planning WARNING!!!!!:
Next Paragraph is X Rated
(read the analogy at your own discretion)
Beating the Dow is Often Just Beating Off
in the context of personal financial life planning objectives
X Rate Trigger Warning Off
The question: is one on track to achieve and or maintain the personal financial life goals – inflation risk adjusted after tax – prioritized? If that requires a higher rate of return than ‘the Dow or S&P’ the question then becomes first 1) can one increase the amount to be contribution for accumulation and or 2) more realistically, can the oughta level and especially the niceta level of the present standard of living amounts be modified – which will have typically a greater probability of sustained impact on the goal(s) rather than trying to beat the Dow – and the increased volatility & anxiety endured.
There are no solutions only tradeoffs
Therefore the question ‘what is one’s risk tolerance’ overall is malpractice without the context of acceptable downside risk willing to be incurred relative to each personal financial goal in priority, sequence & cascade with tradeoffs. Overall risk tolerance enunciations is just ‘it sounds, good has a good beat’ with Bobby Rydell singing Wild One from the American Bandstand. (Alas, I show my age – and past crush on Annette Funicello).
I got principles. You don’t like these principles, I got other principles
In light of the prospect of lower rates of return in the next decade, and compression of asset under management (AUM) percentage fees (i.e. forcing competitive reduction) in light of competing robo advisers, asset under management (AUM) compensated asset managers in personal financial planning clothing planners seek to maintain the same asset under management percentage of compensation. Result: many of these ‘so called’ planners and wire houses have become born again ‘goal managers’ to avoid reduction in fees..
These are many of the same self serving planners that said ‘take out the biggest mortgage you can the interest is deductible’ to, in effect, use financial leverage (and get more asset under management compensation) rather than paying down the mortgage principle. These born again ‘goal planners’ seem to have forgotten ‘their risk tolerance two step’ as financial leverage magnifies also on the downside in effect increasing personal financial anxiety. Now some of these ‘born again’ goal planners are rephrasing the spending levels of gottas (absolute requirements), oughtas (standard of living), and nicetas (luxury – above and beyond) to, in one case, safety (from poverty and anxiety), stability (standard of living) & aspiration. I can only wonder if some of these born again goal planners (though still charging an asset under management fee) have secured the services of former Obama and Clinton parsing spinmeister specialists.. Now it’s human capital being converted to financial capital – sounds good, has a good beat but it is just a re-titling of man at work and dollars at work. But like Starbucks pricing, it seems charge is function of the number of syllables in the coffee order.
You must lose a fly to catch a trout
. ~George Herbert
The ‘newly born again’ AUM goals oriented planner’s business’ has its fly open… (clients now baited with Holy Mackerel?) (1)
And that’s Risky Business even for Mission Impossible’s Tom Cruise.
(1) Years ago, a commission planner asked me how to transition to fee only compensation without losing his clientele. I replied, ‘you have two choices. ‘A’ saying I’m going fee only so I won’t be shtupping you any longer or ‘B’ in one year my practice is transitioning to fee only – up till then it is your choice to go fee only or remain fee and commission.’ Confession, is good for the Sole’- slightly seasoned – even if fishy.
(2) For those unfamiliar – Tom Cruise has starred in Risky Business as well as the Mission Impossible series.