Whoops - Damn

Recently I received word that an arbitration panel rendered a multimillion dollar award in favor of the side that called me as an expert witness.  The chief issue was suitability and all of the facets of this subject.  I won't go into the details but will lay out the NASD/FINRA NTM's (Notice to Members) I discussed in my testimony. They are: NTM numbers: 96-60, 03-07, 03-71, 04-30, 05-18, 05-26, 05-59, 07-43, 08-81, 09-25, 09-73 and 10-09. I make the following Observation:

Suitability

Sometimes insufficient attention is given to the "reasonable basis" process of FINRA's suitability rule. This can lead to disastrous consequences.  With that in mind I thought I might tweak and republish an earlier Observation.

·        Whoops - Damn

People generally don’t start out with the intention of creating the potential for a big problem or for that matter undertaking a risk that if realized would have a significant consequence.  They cut a corner here and then later cut a corner there and so on and one day they wake up and …. 

                     - 01/23/2007 

Update:  As we can see from the Gulf Disaster things can get out of hand.

-0715/2010

Put down the hot dog and step away from the beer

 

The song we will sing on the fourth has, in my view, a central statement about all of us, all stripes, sizes, persuasions, you name the distinction.

Americans are not cowards.

We do not cower when threatened.

We do not sing that ours is the land of the safe and the home of the secure.

On the contrary we sing that ours is:

"…the land of the free and the home of the brave." ¹

We reject attempts to trade our freedoms for expediencies² whether they are urged upon us for the concerns of the right or for the concerns of the left.³

Now go ahead.  Eat that hot dog and drink that beer.  You paid for them.

1.           There are four verses in our national anthem. This line of verse is the only line that is repeated. It is repeated in each of the verses. In all four verses it is the last and concluding line of the verse.

The song was originally written as a poem over several days beginning on the morning of September 14, 1814 by Francis Scott Key, an American lawyer. Mr. Key was held captive on a British frigate and watched a 25 hour bombardment of Fort McHenry which defended the port city of Baltimore from attack.  We were at war with the British who had just sacked and burned our nation’s capital.  They were intent on doing the same to nearby Baltimore unless we surrendered.  Mr. Key knew that as long as the British continued their bombardment the Americans had not surrendered. Not long before dawn the bombardment suddenly ceased.  Because of the darkness Mr. Key could not see whether our flag still flew over the fort. But when the sun rose that morning he could see and he could see without any difficulty. The Americans had not pulled down their flag but had replaced a smaller one with a huge one specially made for the battle, one that was designed to be seen by everyone, friend and foe alike.  The original manuscript of the poem can be seen at

http://en.wikipedia.org/wiki/File:KeysSSB.jpg

2.           Such a sentiment was also very eloquently and convincingly conveyed on March 23, 1775. On June 5, 1788 that same orator was not so convincing and for that I am happy.

3.           In our Bill of Rights alone there is an extraordinary array of rights specified some of which are more readily embraced than others by each part of the political spectrum.

Munger Has The Better View

Recently Warren Buffett expressed his view that Goldman Sachs had acted appropriately in relation to the ABACUS 2007-AC1 deal, essentially stating that he could not understand the public’s consternation with the activities of the investment banking firm.

His partner, Charlie Munger, expressed a different view, that is, that there is a difference between behaving legally and behaving ethically — and that a business should not simply follow the former.

I believe that this time Mr. Munger has it right and Mr. Buffett has it wrong. The distinction between Mr. Buffett’s view and the view expressed by Mr. Munger is important - both on a market scale and on an individual scale.  The distinction in views explains why Wall Street doesn’t think Goldman (and other banks) did anything wrong and Main Street does - emphatically.  Main Street wins this argument hands down.  I will leave it up to the banks to learn or not learn₁.  My focus is on risk management in doing your business.

In our country ethical behavior and honest behavior are mutually inclusive. Societal norms dictate the standard for ethics and honesty. In ours “fundamental fairness” is that standard.

To act in a manner which we do not consider to be fundamentally fair is to behave dishontestly₂.  If you do that, we will not trust you and if we don’t trust you we will not deal with you. If we will not deal with you then - there you go.

I am not going to pick on Mr. Buffett to make my point further.  Rather I will use a leading character from a movie about Wall Street.

Hence the following Observation:

·        Gordon, you were wrong bud

This is an observation I have been working on for some time.  Given developments the past few weeks I thought this was the time to make this Observation. In doing so I am not commenting on current events but on an important underlying theme.

Honesty, rather than fear and greed, is the human characteristic that runs our markets. True fear and greed exist and effect markets and financial decisions but they don’t run our markets, honesty does. Why do I say that? It’s very simple, almost sounds trite, but is nevertheless bedrock true.

Honesty builds trust between individuals and trust is the keystone to successful interaction between individuals in a functional sophisticated society. Where trust is absent societies are dysfunctional.  In those societies markets either do not exist or are dysfunctional themselves and little used.  Our markets are the largest and most successful in the world because historically they have been trusted to be more honest (read that fundamentally fair) than any other market in the world.

So are we honest and if so, why? The answer is that we are, at least in our society.  Honesty is a societal norm in our country (and in some others as well).  Individuals learn societal norms as they grow up.  Our brain records those societal norms in its long term memory and draws on them when confronted with decisions on future actions.  There are distinctly different physiological reactions which occur in the brain relating to actions that conform to societal norms versus those actions which violate societal norms.

FMRI studies have confirmed that there are two parts of the brain₃ that are stimulated (neuronal activity) causing pleasure when a person conforms to a societal norm (or observes someone else doing so).  There actually is a physiological explanation for why you feel good when you turn a wallet you happen upon into the lost and found knowing that the owner will never know that you did it let alone reward you. The same physical phenomenon occurs to you when you learn someone else has turned in that wallet.

Well if this is the case how do we explain the dishonest acts that occur, especially the numerous little acts of dishonesty that are carried out every day by everyday people.  We don’t know for sure yet. We do know that certain portions of the brain₄ are stimulated (giving a negative feeling of discomfort) when a person violates a societal norm (or observes someone else doing so). Those portions of the brain are not stimulated by perceived trivial acts of dishonesty (such as refilling a drink at a convenience store after taking one sip, as opposed to taking a refill after downing the entire drink).  Why significant dishonest acts occur is way beyond the scope of this Observation, but for now just consider that a psychopathological condition may be involved in those acts.

The takeaway from this Observation is that beginning early in our lives we learn the norms of our society.  Brain physiology causes us to store that information and react to the observance/violation of our societal norms on a positive-pleasure/negative-discomfort basis.  People like things that make them feel good and dislike things that do the opposite. Our society has as a norm the concept of honesty (fundamentally fair behavior) and therefore the vast majority of our acts are honest. Simply put we pursue pleasure. This actually helps us as social beings. Honesty promotes trust which in turn allows the individuals in our society to interact with each other successfully and in sophisticated ways.  Each act of honesty builds this trust and each dishonest act tears some of it away.

As for our markets, unless you want to concede first place to someone else (and if you do you are no friend of mine), you should remind yourself of this concept₅ periodically and support efforts by individuals, groups, associations and governments to promote honesty₆. Caveat emptor will not suffice as the ethical standard in any society that wants to have successful financial markets.

You may also wish to consider the foregoing in managing your risk.

1.       I would, however, caution them and Mr. Buffett against the continued use of the word “bet” in their statements about their activities.  Webster’s dictionary may include as a description something that would not be related to gambling, horse racing, craps, roulette or other games typically played at the track or in casinos.   Most Americans, however, associate the word “bet” with behavior that is not associated with investments or investing, speculating or gambling yes, but not investing.  I know what they mean but I am confident that neither the banks nor Mr. Buffett want people to “get the wrong idea”, that is, that someone is playing a hunch with enough money to have nine zeros in the figure before you get to the decimal point.  Surely there would be more intelligent evaluation before they acted in their investment decisions with that kind of money than their action in placing a bet at the track or at a roulette table. Nobody places a billion dollar bet at the track or in a casino, nobody.  Why bets of that size might risk bringing down the house. My comment to the banks and Mr. Buffett is, if you don’t like what is going into the Financial Reform bill now, keep using the word “bet” and see what happens.

2.       Definitions of “honesty” invariably contain the words “fair” or “fairness.”

3.       The nucleus accumbens and caudate nucleus.

4.       Certain specific areas of the prefrontal cortex. The studies to date indicate a positive correlation between the subject’s perception of the probability of punishment for violating a social norm and the stimulation causing mental discomfort. This may explain the “trivial” violation exception discussed above.

5.       Psychological studies have confirmed that individuals who are reminded of the societal norm of honesty thereafter increase their propensity to choose the “honest” alternative when confronted with a decision about future action.

6.       Another societal norm is that group approval or disapproval of our actions is important to us.  In our society the approval or disapproval of our peers is very important and is a significant motivating factor in our decision making process.  Transparency in financial markets amplifies the ability of the “group” to view and evaluate the actions of individuals (and groups, associations, corporations, etc.) in those markets.  Because we care what people think, the positive response to conforming to societal norms is promoted by transparency. We know in advance that people “will look and they will see.”  Therefore, transparency promotes honesty which in turn... (well you can see where this goes).

Never Again! Really? The Devil You Say.

The forthcoming adoption of a financial reform bill in Congress prompted me to republish an Observation I made at the height of the financial crisis.  Here is my Observation:

Last week [the week of September 29, 2008] I was asked to explain one comment in my latest Observation. That comment was that “we all had a hand in it.”  By “it” of course I meant the present economic conundrum.  By “we” I meant to include the population at large.

I was then asked to explain my reasoning and I gave the following explanation:

We are all subject to certain cognitive imperfections.  One of them directly impacted us when the real estate bubble burst and that same imperfection impacted us when the tech bubble burst. The imperfection is:

People have an irrational, compulsive and subconscious belief that a trend will continue far beyond what would be justified by a historical statistical analysis.  They are then unpleasantly surprised when the “trend” ends and things revert to the mean.  Hence the following previous Observation I made over a year ago (when the market was still hot):

·        Yes but this time it’s different

It never is.

Why do you think they named it the “mean?”

Maybe because of the harsh way you can be re-taught an old lesson when something reverts to it.

-          06/18/2007

Ok how does all of the foregoing apply to our present situation [October 2008]?  When real estate began to “take off” (late 90’s) and that market condition continued until the general public perceived it as a trend this “cognitive bias”, called “recency” or trend continuance, took over. People began to buy real estate with the conviction that values would continue to go up. They simply reasoned that if the property turned out to be more than they could afford they could sell it at a profit. That outlook changed the way they perceived the risk of borrowing money (remember that I said in an Observation that when the “possibility” of making a large profit comes in the room a cognitive bias causes “probability” to head for an exit -05/27/2008).

Ordinary everyday people began to take risks that they simply did not perceive as real. What began as a trickle became a torrent the longer real estate continued to appreciate. People began to believe that it was ok to, shall we say, fib on loan applications. They also saw logic in NINJA loans.  Yes that’s how far logic strayed. All of us were aware of what was transpiring.¹   We simply did not perceive how short the trend would last and how far and extensive the damage would be.

Then the trend ended and now -

          We know how mean the mean is.

Of course the lending and financial industries had a hand in it - they encouraged and facilitated this to go on.

People say that we should learn from this and never let it happen again.  Well I am all for that but my hope is balanced by the simple fact that contrary to a precept of classic economic theory we are not “rational” when it comes to economic decisions.  Our shortcomings are embedded in our DNA. 

The best strategy in my view is to remember our shortcomings and do our best with those in mind to avoid repeating our economic mistakes.

In 1991 I read an article by Chris Argyrs in the Harvard Business Review, Teaching Smart People How to Learn.  The upshot of this article is that when events turn out badly we tend to engage in “defensive reasoning”, i.e. blame others for the outcome.² This very effectively keeps us from learning from past experience.  In order to keep history “repetition” to an absolute minimum we need to avoid the onset of defensive reasoning and instead focus on the one thing we had and will have control over which is, our own conduct.  That is why in my previous Observation I said “Whining that it was someone else’s fault isn’t going to help.”

Regulate yes, but don’t be foolish enough to think it will never happen again. Lewis Black, the satirist (03/20/2007 Observation), is no doubt going to have a field day with these peccadilloes.

1. Even those of us that owned property but did not refinance, take out a second mortgage, line of credit or trade up were yelling “run, baby, run – who cares if the kids can’t buy a home.”

2. The more intelligent the individual the more pronounced the onset of defensive reasoning – blaming someone else for a negative outcome. As observers, it is not uncommon for us to be surprised when we observe people we consider to be extremely intelligent, well educated and experienced in the matter at hand to fail to “get it” and insist on proclaiming an argument that no one else is buying.  This I believe explains the reaction many have had to the denials coming from some on Wall Street.

            -10/06/2008

Manure and the Common Man

He gets up at 4am. Puts his feet on the floor and the floor is cold.  It’s April and he is in Iowa.  You know what it can be like in Iowa at 4am in April?  Dark and cold as… damn cold and let’s leave it at that.  For the last month though the weather has been good enough to get the soil ready. It’s not frozen and it’s dry enough, ready to be worked. Nobody made him get up; he doesn’t have a job created by somebody else.  He doesn’t have a boss – except for his family and except for – well let’s leave that for later.  He goes down the narrow staircase to the first floor of his house and into the kitchen.  It’s colder down there, kept just warm enough so the water doesn’t freeze in the pipes. Still has the long johns he slept in on and leaves them on as he pulls on his overalls and his Hawkeyes sweatshirt with the hood.  Pulls the hood up on his head, flips it down again, then puts his DeKalb cap on and adjusts the hood over it. Maybe someday he will get the order of that right. Socks, he looks down at them in the dark room, same socks he had on when he went to sleep last night.  Too cold to take them off.  Boots come next, good ones but old, not too old but getting some age on them.  Gloves next, two pair, one for warmth and one to keep the others from getting torn up.  Goes out on the porch, stops, no wind today.  On mornings like this with a lot of wind, it doesn’t take long for his face to feel as if it is going to fall off.  He takes a deep breath – that’s the only break he is going to take today.  Ok that’s over- let’s get after it.  At a proper pace it will take 10 hours to get it done with a half hour break for some lunch.  The cab is heated though so it won’t be bad, just boring. But he knows what all of this will look like in July, beautiful.  He fires his baby up, the John Deere barks to life, lights come on and he begins.  How many acres today?  Too many - but not enough.  Corn, sure it’s a risk, it’s a commodity and so he hedges his hope. But for this morning no hedge will do or for that matter get the work done, nope there is no hedge for not working.  So he drives off into the dark, no breakfast – that will come on a break, three hours later. He has a radio in the cab.  After his breakfast, about 8:30 Iowa time, he is listening to the radio and hears about Goldman Sachs getting sued by the government.  So they supposedly helped sell something to somebody that was synthetic and backed by/derived from/or somehow related to some mortgages. Mortgages taken out by people who couldn’t pay the mortgages. Mortgages supposedly picked by an outfit that believed the mortgages were probably bad and would likely end up in default.  Then that outfit supposedly bet that they would default.  Supposedly they did default and that outfit made a billion dollars while the folks that got helped out lost a billion dollars.  His initial instinct was to think of a four letter word, but no, he just visualizes some manure and continues driving his tractor. He thinks people have to eat. That outfit isn’t going to feed them, Goldman isn’t and the government isn’t.

I am.

Make that a large pile of fresh manure¹, yep, well at least the Hawkeyes won in Omaha this year, best college wrestling team on the face of our planet.  He wonders how his son is doing taking care of the hogs - there is no hedge for not doing that either.

1.     1. Manure: an end product which eventually may have indirect benefits not intended by its originator.

Oh! So Now You are Sorry?

Last week Messrs Prince and Rubin, formerly of Citigroup, testified before a government commission looking into the financial meltdown.  Having lived through the “experience” I thought I might share some of my earlier Observations.

·        Separating the Truth from Fiction

“Of all the offspring of Time, Error is the most ancient, and is so old and familiar an acquaintance, that Truth, when discovered, comes upon most of us like an intruder, and meets the intruder’s welcome.”

            Charles Mackay – Scottish Philosopher

If you don’t understand something ask for an explanation. If the explanation doesn’t make sense, then ask for clarification.  If it still doesn’t make sense the problem is not you or your capacity to understand. It’s that “it” doesn’t make sense. 

Implying that people who “don’t understand” are dense is a common persuasive tactic of people who themselves don’t actually understand (or worse).

The problems we often encounter are not caused by our lack of mental capacity, but by our willingness to go along with such an implication.

            -03/24/2008

·        Demigod (Demon)

Corporate culture has a negative aspect I would like to address.  I call it the deification (often later demonization) of senior executives.  These folks are not demigods (or demons).  They are not smarter (or vice versa) than before they got promoted (appointed, whatever) and their intelligence and acumen does not vary with the fortunes of the firm.  They are humans just like the rest of us.  Nonetheless this process goes on constantly, often the result of actions by their subordinates.

We are neither unintelligent nor uneducated and don't help ourselves or the firm by buying into the process I have described.

We should overcome the temptation to do so.

          - 07/07/2008

·        Standards do serve a purpose

When the justification is that we have to because “well everybody else is doing it and we have to stay competitive” then it’s time to take a deep breath and remember what happened to …..

          -09/08/2008

·        What happened (11/05/2007)

Here is my take:

People (yes that means everybody) tend to overestimate the accuracy and precision of their knowledge and that often leads to overconfidence and a lack of perception of the amount of risk they are undertaking in making financial decisions. This in turn tends to burn them from time to time and it kick starts the law of unintended consequences hurting others.

10/01/2008 Supplement: Senior executives in financial firms, quasi governmental entities (Fannie, Freddie), and regulatory authorities listened to and accepted the explanation (by senior but subordinate experts) of the “risks incurred” for various proposed offerings and undertakings.  The senior executives and those making a proposal were far too confident that the analysis of the risk/reward balance on the proposal was based on accurate and complete underlying data. That is a classic and oft repeated mistake.  This led to tragic overconfidence and the assumption of a level of risk that was unknown and unprecedented sending the law of unintended consequences off on a gallop.

But make no mistake we all had a hand in this. Whining that it was someone else’s fault isn’t going to help.

          -09/29/2008

·        Prognostication is a four letter word (and so is overconfidence)

I was all set with a different Observation for today but then a financial guru testified before Congress on Thursday.  I read a transcript of part of his testimony and I just could not resist.

What he said was:

It was the failure to properly price such risky assets that precipitated the crisis. In recent decades, a vast risk management and pricing system has evolved, combining the best insights of mathematicians and finance experts supported by major advances in computer and communications technology. A Nobel Prize was awarded for the discovery of the pricing model that underpins much of the advance in derivatives markets. This modern risk management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year because the data inputted into the risk management models generally covered only the past two decades, a period of euphoria. Had instead the models been fitted more appropriately to historic periods of stress, capital requirements would have been much higher and the financial world would be in far better shape today, in my judgment.

What he meant (in plain English) was:

They thought they had it figured out but they didn’t and it turned out to bite everyone on the....*

Overconfident Prognosticators, all of them, including the “guru” (and you know what I think of those guys).

You may wish to reread my 03/31/2008 (“worse than a lollygagger”) and 05/19/2008 (“…use your head Fred…”) Observations. If you don’t have them I will send them to you. I already sent them to the “guru.”

*reminds me of when I was young and used to set off firecrackers with my buddies.  Once we set off several hundred in a row without a failure.  Then one of didn’t go off after being lit.  Georgie Wade stuck his head over the darn thing; it flared up and burnt his eyebrows off.

            -10/27/2008

Behavioral Finance and Economics - Hingsight Bias - Knew or Should Have Known

Recently I testified as an expert witness in an arbitration involving retail stock-brokerage activity.  My client asked that I attend the hearing and observe the testimony of the other witnesses as a prelude to my testimony.  In doing so I was constantly reminded of the cognitive distortion called Hindsight Bias and an Observation I wrote several years ago as an in-house counsel.  I reproduce that piece:

·        Hindsight Bias Revisited

Hindsight bias: The natural tendency of an individual to overweight the probability that an event would occur after being told that the event had occurred.

The most common allegation I see in an arbitration is "knew or should have known."  Often the resolution of "should have known" is the deciding issue.  Its resolution also involves the involuntary and subconscious application of the principle of "Hindsight Bias" by arbitration panel members.

When you judge risk about the future, you judge it with foresight and objectively. When panel members judge risk, they judge it with hindsight and not so objectively (using Hindsight Bias).

Panel members are effectively asked to step back into the past and through the use of their imagination attempt to the judge probability of something occurring (in the then future) when they already know "it" did occur. In their attempt, try as they might not to, they may overweight the probability.

You may wish to keep the foregoing  in mind while managing your risks. 

  -10/30/2006

Don't Stop Managing Your Risk Just Because You Have a Dispute

“I was never ruined but twice - once when I lost a lawsuit, once when I won one.”

                                                      -Voltaire

I write these Observations to help you manage your risks as intelligently as possible.  Nevertheless sometimes problems and disputes over those problems arise.

So when you have a dispute over a problem don't you want to control its outcome (i.e. manage that risk as well)?* 

When your dispute ends up in litigation or arbitration and you finally turn it over to the arbitration panel or jury to decide you, at that point, give up total control over your fate.  Think about potential panel or jury members and how well you will know them. Why would you give up that degree of control over the resolution of your dispute to total strangers? Here is a link to a recent federal appellate court decision which I think dramatically tells us what unforeseen events may occur once we do turn over that control (in this case at least three times).  I do not cite this case for any proposition other than the line from the movie Forrest Gump "You never know what you're gonna get." Now for the link: 

http://pacer.ca4.uscourts.gov/opinion.pdf/091038.P.pdf *

Think about about mediation, you do, after all, retain control during the entire process. You are not alone in controlling the outcome but then you never are in arbitration or litigation. When you are mediating a dispute you are actively managing your risk.  Not so in the other forums - as I said when your evidence is in and the arguments are over and you turn your case over to a panel, judge or jury all risk management ceases. You better hope that a good jury, judge or panel showed up for your case and the bad ones somehow went to a case on the other coast.

* my thanks to my acquaintance Marc Dobin, a securities lawyer in Jupiter Florida, for a recent blog post which alerted me to this case. Marc's blog can be found at http://lawyersfromjupiter.blogspot.com/

Behavioral Finance and Economics - Reciprocal Altruism and Homo Economicus

“Economic Humankind” is, according to classic economic theory, made up of individuals who possess the attributes of unbounded (1) free will, (2) self-interest and (3) rationality.  I reserve for another day an Observation on “unbounded rationality” and today take a short look at the concept in classical economic theory that we are selfish and self maximizing (unbounded self-interest).  Dr. Michael Shermer, in his book The Mind of the Market: Compassionate Apes, Competitive Humans and Other Tales from Evolutionary Economics, describes the moral emotion of “reciprocal altruism” or “I will scratch your back if your scratch mine” – to which I politely add, “or if not take a hike.”  This moral sense of fairness is hard wired into our brains and according to Dr. Shermer, present in all humans and primates tested for it.  It was developed during our formative years as “hunter-gathers” as a means of self preservation of the tribe but has continued to exist even now that we, in the words of Dr. Shermer, have morphed into “consumer-traders” in a large society. As I stated this reciprocal altruism trait has been repeatedly confirmed, more specifically, in a test dubbed the “Ultimatum Game” by behavioral economists.  In the game participants are paired up and one of each pair is given $100 with a condition.  That person is ordered to propose a split of the funds between her/himself and their game partner. If a proposal to split the money in a particular fashion is accepted by the partner then each get their agreed upon proportion.  If the proposal is not accepted then neither gets any portion.

Classical economic theory would tell us that no matter what the proposal is (assuming it was not 100 to zero) the trading partner will, without exception, accept.  The reasoning is that the partner is a Homo Economicus and will not turn down free money (no matter how small or disproportionate the share).
Results of the game in operation show that anything less than a 70 -30 split is usually rejected.  You are not surprised.  Now why would that be?  Well no doubt you have concluded that less than a 70-30 split is not viewed as fair.  No kidding. But although fairness is not a concept in classic economic theory - it is in human psychology - the moral emotion of “reciprocal altruism.” See your conclusion is really the operation of this trait and by the way it’s a reflexive action not a reflective one which once again means it’s invocation is subconscious and compulsive (don’t know it and can’t help it).

You may wish to consider the foregoing as further evidence that psychology matters when analyzing how an investor may confront economic dilemma. In addition you may wish to consider whether something you did or propose will be analyzed by others as being fair and if it’s not whether the moral emotion of reciprocal altruism will have an effect on the evaluation of your proposal (or historical action)*.
*For those of you in the dispute resolution business I bet you can see several important implications.
As a postscript today I thought I would give you the following link to Paul Krugman’s article in a Sunday edition of the New York times.   http://www.nytimes.com/2009/09/06/magazine/06Economic-t.html?_r=1&em

Financial Plans and "Flexibility"

We can learn a lot about improving our financial plans and the financial plans and advice we give our clients from Leo Tolstoy and Robert Burns.

War and Peace – The Novel

In Tolstoy’s view (extensively expressed in the novel) history was not created by great men or significant events. Rather history was the result of the interaction of millions of individual chains of cause and effect too small to be analyzed independently.The principle “great men” in the novel, Napoleon and Czar Alexander, may have believed they were in charge of their destiny but in fact they were caught up in the same web of circumstance as the rest of us.

In addition, Tolstoy emphasized the irrational motives for human behavior and hence the total unpredictability of unfolding events.  A central premise of the novel was that Napoleon never intended to invade Russia but was drawn into it and did not comprehend the forces that led him to do so.

Tolstoy linked wisdom not to innate logic or reason but to an acceptance of the foregoing state of affairs.  In Tolstoy’s view General Kutuzov, the leader of the Russian forces opposing Napoleon’s invasion, emerged as a great leader not because he developed a logical battle plan and then demanded that everyone follow it as events unfolded.  Rather, Tolstoy explained, Kutuzov’s genius lay in the fact that he was willing to adapt to the flow of events and think on his feet. In General Kutuzov’s experience each stage of a battle turned out to be vastly different from what was expected (by everyone). Based on his experience Kutuzov devised very flexible battle plans and allocated his resources accordingly.  Kutuzov often slept through battles after they began, leaving to his lieutenants the ability to react to changing circumstances. Kutuzov eventually defeated Napoleon.

Well I don’t recommend that you go to sleep but I do recommend that you “be (Tolstoy) wise” and accept the fact that you cannot predict what will happen in the future (both in the markets, in your personal lives  or those of your clients).  Build in flexibility to your financial plans and the advice you give your clients.  Then you can be a modern Kutuzov.

My point:

Don't build a plan based on an anticipated future and then change the plan when the future does not turn out as anticipated. Build your plan to take as many contingencies as possible into account.  It's the difference between a great plan and an ordinary plan - between winning and losing.

Robert Burns, the national poet of Scotland wrote a poem which eloquently describes our human dilemma.  I reproduce a part of it below.

“To a Mouse” by Robert Burns

"But, Mousie, thou art no thy lane,
In proving foresight may be vain;
The best-laid schemes o' mice an 'men Gang aft agley,
An'lea'e us nought but grief an' pain,
For promis'd joy!

Still thou art blest, compar'd  wi' me
The present only toucheth thee:
But, Och! I backward cast my e'e.
On prospects drear!
An' forward, tho' I canna see,
I guess an' fear!"