Under Pressure
A PLANE’S ALTIMETER measures the airplane’s altitude. It’s a critical instrument—so important, in fact, that planes are typically outfitted with two. That’s for redundancy, in case one fails. In addition, because different altimeters work better in different conditions, the two readings offer pilots multiple points of reference.
I was speaking recently with a retired pilot, who explained this to me and asked how he could apply the notion of redundancy to his finances. It was a good question, one that’s relevant to anyone building a financial plan.
Let’s start with the numbers. Statisticians like to joke about the six-foot man who drowned in a river that was five-feet deep on average. The idea is that we need to be careful in how we use statistics, and this certainly applies to financial planning. We know, for example, that historically the U.S. stock market has delivered 10% annual returns, but that figure is a 100-year average. In our own retirement, each of us will experience some set of market returns, but we don’t know whether those returns will be better or worse than the long-term average, and that could make all the difference. How can you navigate this uncertainty?
One way is to assume that future returns will be lower than they’ve been in the past and to assess the impact of those lower returns on your plan. That approach would make sense especially right now, after the strong above-average returns we’ve enjoyed over the past decade.
Another approach would be to use Monte Carlo analysis. This is a statistical technique that gauges the likelihood of a plan’s success under different market conditions. It has its own strengths and weaknesses, but can be helpful in illustrating the probability of various future outcomes.
How else can you account for the uncertainty of market returns? I suggest turning the dials on more than one variable. What if you varied your expected spending rate or looked at the impact of moving? It’s useful to examine alternative scenarios even if you don’t know precisely which way things will go.
Another way to pressure-test your plan is to do what the late Charlie Munger often recommended. “Invert,” he said. “Always invert.” The idea here is to turn a problem on its head, to look at it from more than one perspective. In addition to asking how you might set your plan up for success, also ask what might cause it to fail? While none of us can see the future, an advantage we all have is we know our own circumstances. That puts us in a better position to assess which risks will likely be most relevant. Some folks worry more about their health. Others worry about their living situation or about the wellbeing of a loved one.
Another important step is to tune out unnecessary noise. Alberto Brandolini is an Italian software engineer. In observing the amount of misinformation on the internet—and how quickly it can spread—he coined what he called Brandolini’s law. It postulates that the amount of energy needed to refute misinformation is an order of magnitude greater than the effort required to produce it. Because Wall Street’s marketing machine is often in overdrive, this is a key point. In constructing your plan, try to steer clear of sales pitches for the Street’s latest “innovation.”
In the last interview he gave before his death in 1976, Benjamin Graham offered this advice: “The present optimism is going to be overdone and the next pessimism will be overdone.” And this cycle simply repeats. “You are back on the Ferris Wheel,” he said. This is another important idea. In constructing a plan, it helps to be skeptical of the prevailing sentiment of the day, whether that happens to be excessive optimism or extreme pessimism. Instead, stay focused on your plan and your goals.
On this point, it’s worth keeping in mind the history of the transportation industry. Before automobiles gained popularity in the early 1900s, it’s estimated that there were more than 4,000 companies in the horse-and-carriage business. In hindsight, it’s clear that the right move for them would have been to try to transition to automobile manufacturing. Carriage makers had relevant skills and were well positioned to make this leap.
But they adopted a collective mindset that the automobile wasn’t going to succeed. They referred to cars as “devil wagons” because, early on, they were noisy, unreliable and dangerous. As a result, just one carriage maker, Studebaker, correctly assessed where things were going and successfully shifted to making automobiles. Every other one of those 4,000 companies was so convinced of an alternate reality that they put themselves out of business.
This carries a lesson for financial planning. There’s no virtue in being contrarian simply for the sake of being contrarian. But in making a financial plan, it sometimes helps to consider viewpoints that differ from what everybody “knows.”
In their book, Like, Martin Reeves and Bob Goodson explain the art required in soliciting opinions from other people. On the one hand, there’s an advantage in casting a wide net. Diverse opinions help us sharpen our thinking. But there’s also a key advantage in talking to people who are just like us: Their knowledge and experience is most relevant. A chef will want to consult another chef with a cooking question. But that has its limits. At the advent of the automobile, horse and buggy makers probably leaned too heavily on each other in discussing the future of their industry, thus creating an unhelpful echo chamber.
There’s no easy answer to this. But if it seems like everybody is looking at a single altimeter, it might make sense to consult another one.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam's Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.
I was speaking recently with a retired pilot, who explained this to me and asked how he could apply the notion of redundancy to his finances. It was a good question, one that’s relevant to anyone building a financial plan.
Let’s start with the numbers. Statisticians like to joke about the six-foot man who drowned in a river that was five-feet deep on average. The idea is that we need to be careful in how we use statistics, and this certainly applies to financial planning. We know, for example, that historically the U.S. stock market has delivered 10% annual returns, but that figure is a 100-year average. In our own retirement, each of us will experience some set of market returns, but we don’t know whether those returns will be better or worse than the long-term average, and that could make all the difference. How can you navigate this uncertainty?
One way is to assume that future returns will be lower than they’ve been in the past and to assess the impact of those lower returns on your plan. That approach would make sense especially right now, after the strong above-average returns we’ve enjoyed over the past decade.
Another approach would be to use Monte Carlo analysis. This is a statistical technique that gauges the likelihood of a plan’s success under different market conditions. It has its own strengths and weaknesses, but can be helpful in illustrating the probability of various future outcomes.
How else can you account for the uncertainty of market returns? I suggest turning the dials on more than one variable. What if you varied your expected spending rate or looked at the impact of moving? It’s useful to examine alternative scenarios even if you don’t know precisely which way things will go.
Another way to pressure-test your plan is to do what the late Charlie Munger often recommended. “Invert,” he said. “Always invert.” The idea here is to turn a problem on its head, to look at it from more than one perspective. In addition to asking how you might set your plan up for success, also ask what might cause it to fail? While none of us can see the future, an advantage we all have is we know our own circumstances. That puts us in a better position to assess which risks will likely be most relevant. Some folks worry more about their health. Others worry about their living situation or about the wellbeing of a loved one.
Another important step is to tune out unnecessary noise. Alberto Brandolini is an Italian software engineer. In observing the amount of misinformation on the internet—and how quickly it can spread—he coined what he called Brandolini’s law. It postulates that the amount of energy needed to refute misinformation is an order of magnitude greater than the effort required to produce it. Because Wall Street’s marketing machine is often in overdrive, this is a key point. In constructing your plan, try to steer clear of sales pitches for the Street’s latest “innovation.”
In the last interview he gave before his death in 1976, Benjamin Graham offered this advice: “The present optimism is going to be overdone and the next pessimism will be overdone.” And this cycle simply repeats. “You are back on the Ferris Wheel,” he said. This is another important idea. In constructing a plan, it helps to be skeptical of the prevailing sentiment of the day, whether that happens to be excessive optimism or extreme pessimism. Instead, stay focused on your plan and your goals.
On this point, it’s worth keeping in mind the history of the transportation industry. Before automobiles gained popularity in the early 1900s, it’s estimated that there were more than 4,000 companies in the horse-and-carriage business. In hindsight, it’s clear that the right move for them would have been to try to transition to automobile manufacturing. Carriage makers had relevant skills and were well positioned to make this leap.
But they adopted a collective mindset that the automobile wasn’t going to succeed. They referred to cars as “devil wagons” because, early on, they were noisy, unreliable and dangerous. As a result, just one carriage maker, Studebaker, correctly assessed where things were going and successfully shifted to making automobiles. Every other one of those 4,000 companies was so convinced of an alternate reality that they put themselves out of business.
This carries a lesson for financial planning. There’s no virtue in being contrarian simply for the sake of being contrarian. But in making a financial plan, it sometimes helps to consider viewpoints that differ from what everybody “knows.”
In their book, Like, Martin Reeves and Bob Goodson explain the art required in soliciting opinions from other people. On the one hand, there’s an advantage in casting a wide net. Diverse opinions help us sharpen our thinking. But there’s also a key advantage in talking to people who are just like us: Their knowledge and experience is most relevant. A chef will want to consult another chef with a cooking question. But that has its limits. At the advent of the automobile, horse and buggy makers probably leaned too heavily on each other in discussing the future of their industry, thus creating an unhelpful echo chamber.
There’s no easy answer to this. But if it seems like everybody is looking at a single altimeter, it might make sense to consult another one.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam's Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.The post Under Pressure appeared first on HumbleDollar.
No comments have been added yet.
