As financial advisors, dealing with predictions ultimately leads to errors or, even worse, disaster. But rather than grapple with all of the decisions that need to be made, such as the future of the economy, stock market, health or longevity, there is a simpler way of dealing with uncertainty—focus on the magnitude of the occurrence not on the probability.
To deal with outcomes, financial advisors have been fed a trove of statistics as to why they should invest in an asset allocation of stocks and bonds or whether or not to buy long-term care insurance or self-insure. But these concepts have missed a significant point. It is not the probability of something occurring, but the magnitude of that occurrence happening that is so important about planning.
What do I mean? This post will explain as I dive into how you as a financial advisor and business owner can live with uncertainty as well as help your clients plan for the unknown.
Let’s look at an example. Having life insurance on the sole breadwinner is not a bad idea. Of course, this person may be healthy and survive until he is 90. But the benefits to his family of having insurance are insurmountable if something unexpected were to happen to the breadwinner.
A friend of my wife’s family survived the unexpected death of her husband because of life insurance. When the breadwinner passed, he left his wife and four kids. Thanks to his life insurance, the family was able to stay in their house, pay for the wife to go back to school and live like they had before the death without too much sacrifice.
The concept of how to thrive in uncertain times is highlighted in Nassim Nicholas Taleb’s book Antifragile: Things That Gain From Disorder as well as in his article “Learning to Love Volatility”, which appeared in The Wall Street Journal. Mr. Taleb is also the author of Fooled by Randomness and The Black Swan, which also focus on making decisions in uncertain times.
What cultivating antifragility does, Taleb says, is enable us to minimize the potential harm from negative “black swans” (large events that are both unexpected and highly consequential), while capturing the benefits of positive ones.
As in past posts on www.auminabox.com, let’s look at an analogy from nature and how wildlife has thrived amidst uncertainty. The research article “Flowers help bees cope with uncertainty: signal detection and the function of floral complexity” highlights how flowers have adapted to thrive in a world of the unknown. The article proposes that flowers thrive by enticing pollinators through smell, feel, taste and sight. Flowers have developed this four-stem approach to flourish. Essentially, the flower has four plans. That said, if nature has developed by having a plan A, B, C and D, why, as humans, are we not doing the same?
Boost Returns with the Barbell
So how is it that humans, and specifically financial advisors and consultants, can thrive in a world of uncertainty? Hit the barbell. No I do not mean go to a gym and sweat out an answer. I mean apply a barbell approach.
I have heard many a financial advisor say, “We will take a middle approach,” or “We will do THIS to balance out a potential outcome.” Ultimately, the outcome is wishy-washy because there is no stand. They will not take a risk with option A because option B might occur so they take the middle ground.
But is this in the best interest of the client? Often, we avoid risks. Taking a middle ground seems least harmful.
Unfortunately for investors rewards are bestowed to risk takers. Take Apple, for example. I hear people say, “If only I invested in Apple eight years ago.” But the outlook for Apple eight years ago was grim. Steve Jobs himself lost his fortune from building Apple the first time around with investments in NEXT and Pixar. Apple computers were the forgotten stepchildren. And then there was the iPod: certainly not a new idea. MP3 players were already in existence. However, through slick design and easy configuration, Apple introduced the iPhone, iPad and improved MacBooks. To know of Apple’s success would have been luck at best. There were no clues to tell you otherwise.
Let’s say that your ‘plan A’ was to only invest in Dell and Microsoft, the two kingpins in the market at the time. However, let’s say that you also had a ‘plan B’ (your barbell approach) and invested money in Dell and Microsoft but also allocated a small amount to Apple. You believed Dell and Microsoft were the kingpins. But, you also felt Apple brought bright ideas and they may again produce a tantalizing product so you didn’t completely ignore them. The end result is that having an investment in Apple boosted potential gains.
Plan B would have benefited your portfolio without taking too much downside risk if Apple were to have gone out of business. With plan A, you missed out on the upside.
This is a barbell approach to investing. You are taking a stand, making a commitment on an investment idea and avoiding the wishy-washy middle ground.
The barbell approach can also be applied to cash flow management, health insurance, life insurance and longevity planning.
Let’s look at an example for disability and life insurance. As we all know, insurance is a hard product to sell because it is so difficult to conceptualize–it is not tangible.
A couple of years ago, a financial advisor I worked with had a client who was an eye surgeon. The eye surgeon was benefiting from the boom in Lasik surgery. He had purchased a fabulous house with great vistas and was completing an amazing deck that cascaded down the hill with porticos and hot tubs.
The doctor was a big proponent of education. He wanted the best for his kids, who were ages 11 and 13 at the time. His plan was to pay for their education through his hefty annual income.
He was a symbol of health. He worked out regularly, and he ook pride in his own doctor telling him he had the body and heart of a 30 year-old. Then, out of the blue, he was diagnosed with cancer. Within two months the carcinogens spread to his entire body, and he died.
Despite encouragement from his financial advisor to get disability and life insurance, the doctor had declined. The death was traumatic, not just because a father passed, but also because the sole breadwinner and provider for two smart, thriving children was now gone.
Risks in life are suppressed and hidden from the observer. As humans, we deny the likelihood of events. However, inaction, like failing to plan for the uncertain, only leads to greater disaster.
Barbell or Bust
When coaching financial consultants, I recommend using a barbell approach as a planning option not just for investing, but also for planning for your uncertain future. Take a stand. Make talk less cheap, and have your clients create a clear plan (or plans).
The defining characteristic of future change, according to Taleb’s Antifragile: Things That Gain from Disorder, is that it is impossible, and foolhardy, to try to predict it. Rather than predicting an outcome, having at least a plan B, and in some cases plan C and D like a flower, can boost your returns as a business owner and a financial advisor.
Work on utilizing the barbell approach not just for your own business, but also as you advise clients. Take a stand, open yourself and your clients up to higher yields while minimizing risk.
- Barbell Approach Only Way to Lift Heavy Economy – Bloomberg
- Using Black Swan and Antifragile Analysis for Tech Stocks