The (arguably boring) importance of a strong Plan B

The new new thing at One Day In July is that Paul Barry has joined the firm and opened a Portsmouth, NH office (603-531-3773). To those of you who know Paul and are now on this newsletter, welcome. Other than his unusual penchant for surfing in the Atlantic in the winter, Paul is a normal individual with an abnormally strong belief in low fees and ethical behavior. I'm more than glad he's on board.


It wasn't just the skiing that made Warren Miller's films remarkable. The characters had a certain personality that one does not see every day around the office. One particular scene sticks with me: a California-like skater dude looks straight into the camera, and says in a genuine tone "I'll have you know, when I ski, I always have a Plan A and a Plan B." Miller then cuts immediately to a scene of this gentleman doing a spread eagle aerial off a 100 foot cliff.

That's the thing about Plan B when it comes to investing. Plan B, otherwise known as "risk protection," has to be real. No aerials allowed.

In almost all cases with new clients, we find ourselves increasing the risk protection, restructuring portfolios so that Plan B is rock solid.

Clients who have been with us for a year or so sometimes notice that we rarely suggest other financial products. Like annuities, or hot new funds. My opinion on new financial products tends to fall somewhere between skeptical and horrified, and importantly, we have no financial incentive to sell anything. No one pays us other than clients.

The only way we do better financially is if our clients do better first. And this is where we have to be careful as an advisor, because the academic logic and the real-life game plan diverge.

Viewed in a historical context, the academic temptation is to mimic that which has produced optimal returns. If we were to do this, our portfolio recommendations would be different. For example, we would still use a matrix of index funds, but they would likely be all small cap, all value, all equity instruments. Then, in theory, we would add low-cost, long-term, non-callable leverage.

In practice this would be unwise - correction - exceedingly unwise, for two reasons. First, the future likely won't resemble the past, so constructing a strategy rooted only in history probably is erroneous. Second, the combination of the indexes above and the leverage would generate large swings in the value of the portfolio. While some people could withstand this, most would alter their behavior at the wrong time. The academic data quickly would seem irrelevant, and once investor behavior changed, it would be.

But you can see the temptation for both client and advisors - it's to reduce the risk controls and reach for returns. I see this frequently in portfolios that we review for potential clients. The "B" in "Plan B" drops to more of a "b."

This is a subtle but important area. I want you to know that we're watching it and controlling for it internally.

Dan Cunningham

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