Compare your finances to standards of excellence and use them to make enhancements
When people with wealth describe to me how they view their current position, they use a wide variety of yardsticks to measure themselves. Some are troubled because they are comparing their finances to friends, family, or associates who appear to be much better off. Others are troubled because they have lost a large portion of their net worth through market declines, bad investments, or business setbacks.
It is more common, though, to meet people who feel quite confident and secure because they’re doing much better than they imagined they would when they were younger. Their confidence may be fueled by the good opinion of others around them, since wealthy, successful people are often accorded tremendous respect and kid-glove treatment.
There is nothing wrong with these benefits of success, but you can’t allow them to lull you into false assumptions about your financial position. If you want to know where you really stand in terms of financial strength, you need to employ objective standards of excellence.
In this article, I will discuss what I call the first guiding principle for managing wealth:
Make your balance sheet, cash flow, and portfolio your friend
There is a critical distinction between possessing a high net worth and having a strong balance sheet, cash flow, and portfolio. Problems in these three areas can give rise to huge frustrations and mistakes. The predicament of a gentleman I’ll call “Harry” illustrates this point.
In terms of net worth, Harry was in an excellent position, with total assets valued at somewhere north of $60 million. I would have thought it safe to assume that his balance sheet, cash flow, and portfolio were spectacular, but that was not the case. A very high percentage of his assets was locked up in a private company he owned, or in his homes and other personal property. In fact, when I first met him, his liquid and semi-liquid assets were not sufficient to sustain his rate of spending for much longer. Though he had a $3 million portfolio, he was beginning to tap it at an unsustainable rate. Harry was wealthy and he felt wealthy, but he was heading toward an inevitable cash crunch.
Part of Harry’s problem was that he needed to be more cost conscious. A lot of his cash flow problems came down to over-paying for various goods and services. His mortgage payments were much higher than they needed to be. He was bleeding cash in the form of high brokerage fees. He was paying far too much for financial advice and services that were focusing on the 85% Trap and missing the Essential 15%.
Note: This Post will be updated by the author throughout the week ahead as developments unfold related to Brexit
Brexit: an example of creative destruction?
To understand the Brexit ‘Leave’ decision, you must understand one of the most powerful underlying forces shaping our world today: Creative Destruction. Understanding this concept can be the difference between tremendous investment success and failure in the years and decades ahead.
Creative Destruction, a term first coined by economist Joseph Schumpeter in 1942, is the continuous cycle of innovation and destruction behind all economic, business, and life cycles. This concept can be applied to businesses, careers, products…and yes…government organizations.
I have been a long time student of creative destruction and use it as a lens to view the world going through unprecedented levels of change. It’s a comprehensive way to assess perceived and real investment dangers and opportunities.
In business, when bright, creative employees sense they are in a “stagnation mode” organization, they naturally decide to leave the stagnant/status-oriented organization and are often attracted to a new up-and-coming organization that is gaining traction and growing (or promises to grow). Technically, this can leave the stagnant company with less creative talent which can accelerate the journey of the remaining company (theoretically full of bureaucratic, red-tape-type regulators) into a depletion mode. That company either rises to the occasion and reinvents itself or gets further entrenched into stagnation or depletion mode (see graphic).
As for Great Britain and Brexit, could this country be one of the confident/talented equivalents in the European Union (EU) choosing independence and seeking traction and growth on its own terms? I think there is a possible correlation. When someone (or some company/country, etc.) attempts the breakout, they are seeking to gain traction in the new environment and they very naturally can expect to get push-back from the stagnant/status forces that remain. Look for evidence of this in the weeks, maybe years ahead but don’t take it as gospel (it could be fear based PR targeted at undermining the change or it could be a genuine critique). For instance, when electric light was the breakout solution from gas light, gas companies attempted to advertise the threat of being electrocuted as a form of resistance against the breakout threat. The real test for a company, employee or government is: do they have enough gusto and intestinal fortitude to make it through resistance and gain traction with the new idea?
Principles for Devising a Robust System
Henry Ford’s solution to paying workers for time spent “walking about” was a new system, the assembly line, an idea he adapted from the overhead trolleys used in the meat processing industry. “The first step forward in assembly came when we began taking the work to the men instead of the men to the work,” Ford later wrote. That slight but critical shift in thinking led to a huge leap in productivity. Average production times for a car fell from 21 days to 9 hours. The price of a Ford-made automobile fell from $950 in 1909 to $355 in 1921.†
Like any successful system, Ford’s assembly line was designed around guiding principles.
- Each worker would have one task and one task alone.
- The line itself had to be “man high” so that workers would not waste time and get fatigued by constant stooping.
- The speed of the line was calibrated to ensure that a worker was neither rushed nor left biding his time. “He must have every second necessary,” Ford wrote, “but not a singe unnecessary second.”
The tragedy in Orlando last Saturday has shaken the nation while rekindling policy debates on gun control, immigration, and terrorism. These issues are among many cited by the pessimists as
catalysts for the end of the bull market in stocks. But the odds are that they’re likely wrong, and here’s why.
The coming weeks bring us the Federal Reserve meeting on interest rates and Britain’s vote on exiting the European Union. And as my colleague Kyle Kersting recently noted, the U.S. presidential election adds regular headlines that jolt markets higher and lower. The problem, however, isn’t the actual risk any of these topics pose, but rather how we feel about such risks.
What can you learn about systematic investment management from Henry Ford?
Henry Ford is recognized as the father of the auto industry, largely on the strength of one innovation: the automotive assembly line. Looking back at the process he pioneered, Ford recalled the inefficiencies it replaced:
A Ford car contains about five thousand parts. … In our first assembling, we simply started to put a car together at a spot on the floor, and workmen brought to it the parts as they were needed in exactly the same way one builds a house. … The rapid press of production made it necessary to devise plans of production that would avoid having workers falling over one another. The undirected worker spends more of his time walking about for materials and tools than he does in working; he gets small pay because pedestrianism is not a highly paid line.†
Ford knew that in his new system, the assembly line, there were high-value tasks, such as welding the parts of a car together, and there were tasks with little or no value, such as fetching tools and parts. The more workers were occupied by the former tasks and not the latter ones, the more efficient the overall system became.
Thus far, the 2016 presidential race has been nothing short of surprising. It has been laden with controversy and criticism. With a victory in California, Hillary Clinton is the clear democratic nomination frontrunner. Donald Trump, the only Republican candidate left in the race, has won enough delegates to clinch the GOP party nomination.
While the outcome of the election is still months away, history suggests the markets respond far better to a predictable outcome. Markets hate uncertainty. Investment managers will seek clarity over the coming months by looking carefully at the economic proposals of each candidate. For example, markets might respond well to a reduction in the corporate tax rate, a bullish economic indicator. Party affiliation does not offer much insight into strong or weak performance of capital markets. We can look back to times when markets have performed well under both parties.
An exceptional quarter century came to a close
Most investors today in mid-career or nearing retirement age have prospered in what I would term a secular, multi-asset, mega-bull market – a multi-year period of above average returns in several asset classes primarily at the same time. During this time, investment management did not necessarily require the same discipline as in later years.
It is often useful to review bull and bear market cycles in retrospect, because the full extent of the extremes are revealed. Looking back on the previous bull market cycle, the 25-year period from 1982 to 2007 was arguably the single best quarter century ever enjoyed by U.S. investors. Bonds were in a bull market that extended throughout this whole period. Stocks were in a secular (long-term) bull market from 1982 to 2000. There was one memorable decline in 1987, when the market suffered its largest one-day drop in history (22.6 percent). But that “Black Monday” proved to be a mere hiccup in the Dow’s climb from a value of just over 800 in 1982 to 11,722 in January 2000.