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The Importance of the Rules and Dangers of Breaking Them

There’s a harmful statement many entrepreneurs are fond of listening to “rules are made to be broken”.  If that’s the case you’re following the wrong set of rules.  Effective rules are designed to give you the best results.  Consider traffic laws if you started driving on the opposite side of the street what would happen?  It would create chaos and slow everyone down, it might work in a small situation but on average respecting and following the traffic rules helps traffic to flow better for everyone.  The same is true for business and investing.

At Richucation we make a point of teaching the universal rules.  Lots of sources preach rules that are a bit like “don’t put your elbows on the table”, they might be conventionally accepted by they aren’t truly important in the modern age at least not in most situations.  But there are essential rules in business and investing, rules designed to ensure you are consistently growing and making money, you can break them now and again and get away with it but it’s unwise because in the aggregate you’ll end up losing out.

All too often I’ve made this mistake, allowing an employee to do something that breaks the rules to encourage them to take risks, unfortunately they were risking my money not their own, we lost money and I should have intervened.  Getting involved in a business whose foundation wasn’t solid, at first it seemed great, the lie I’d allowed myself to believe, and ultimately it lost money.  Skipping the process of acquiring security on an investment relying on the integrity of the participants and strength of the venture to move forward.  Or failing to put something in writing for mutual agreement, or proceeding without getting an agreement signed and then discovering the terms I expected weren’t honored.  The list goes on, the point is rules such as these, unwritten and even unknown though they might be for most are designed to facilitate success and it’s unwise to violate them.

What are some examples of these rules?

  • Buy/engage with a margin of safety
  • Don’t get involved in something you don’t understand, increase expertise to expand where you operate
  • Test small then scale
  • Get great quality data and use it to make your decisions

As you explore business and investing, wealth building, you’ll learn there are certain foundational essentials and that you shouldn’t avoid these.  Don’t get involved in a non-repeat business.  Get involved in businesses based on growth first, only then consider price, people with high integrity have no problems putting agreements in writing.  The list goes on, suffice to say there are rules, but more importantly you must stick to these rules, at times there will be emotional pressure or perhaps a sense of rebellion to break them but don’t, they are meant to be followed not to restrict you, but to enhance your success.  When you don’t follow them, the tendency is to lose time, opportunity, and money, you might gain a little in some way that’s easy to rationalize, but it’s nothing compared to what could have been gained if you’d just followed them.

Have a question about the fundamental rules of business and wealth building?  Want to run a question, thought or idea by us?  Feel free to contact us by clicking “Ask a Business Question” in the lower right corner of the screen.

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The Worst Question Financial Advisors Ask You

I recently read an article about “what should I do with my extra cash?”

The basic premise here is cash loses value over time so you want to minimize how much cash you’re holding keeping only enough liquidity around to deal with your needs and provide a buffer so you’re not forced to sell investments when they are down.  With this in mind the question makes perfect sense.  Unfortunately, the answer reflected the common nonsense you often hear from financial planners.

Let’s start with the basics.  FINANCIAL PLANNERS ARE NOT INVESTMENT EXPERTS!

What?  You ask isn’t that the point?  Maybe it’s supposed to be but in practice virtually none of them do better than the market investing their own money in fact most do worse.  In other words they aren’t necessarily great sources of information.  Worse, they are USUALLY incentivized by getting commissions based on the products they sell you, hardly an impartial source of information.  This isn’t always true of course there are financial fiduciaries who can be very good but they are the rarity and still aren’t necessarily skilled investors.

That’s a buyer beware.

Now back to the main subject here, which is a question I hear from financial advisors and planners all the time “how much risk are you willing to take on?”  AWFUL!

Why is this question so bad?

Well, we’ve talked before on numerous occasions both in our training and blog posts as well as books, etc. about how risk is defined and how it isn’t defined in a meaningful way.  Technically, the answer to the question should always be “I want the best risk weighted return”.  Here’s an example, it is NEVER sound financial advice to tell someone to buy lottery tickets.  I don’t care what their tolerance for risk is it’s bad advice but that’s what the question implies.  In other words the question comes from a place that is uneducated, which is a good reflection of the investment knowledge of most financial advisors.

Good financial advice should maximize the risk weighted returns for clients, always period there is really no other value or purpose of a financial advisor if they aren’t helping you to get a better return on a risk weighted basis then they aren’t doing their job well after all why would you pay them if not for this?

So let’s talk about what the real question should be when you get into the conversation.  “What is the time horizon in which you’ll need this money and consequently how much volatility is safe?”  In other words if you buy something with a fair bit of volatility there’s a risk you’ll be forced to sell when it is down.  That is the ONLY risk that should be considered in this part of the equation the so called “risk appetite” because all the other risk should be balanced against returns so on a risk weighted basis you’re getting ahead.

Why are other questions about risk nonsensical to ask a client?  Because it implies that there is somehow a correlation between risk and return.  In other words to get higher return you have to take on more risk.  The problem is that’s false.  You might…maybe, have to take on more volatility.  You’ll definitely have to take on greater exposure to the underlying asset but that’s not the same as risk.  Remember the way we define risk that is actually meaningful to people?

“What is the chance of loss and severity of loss?”  That’s risk the way it matters.  In this sense as we’ve noted in other articles increased volatility can actually decrease returns so decreasing risk by that definition actually increases returns.  Likewise for choice of asset class and price of asset class.

Financial advisors should be helping you to simultaenously decrease risk while increasing returns.  To do this they need to consider your financial needs over the next little while and they should educate you about potential investment performance and how to cope with potential events psychologically.  But on no planet should they be guiding you into higher risk weighted investments that’s just bad financial advice.