Tuesday, February 7, 2012

Things FLG Has Learned

FLG is in the home stretch of his MBA and was reflecting on some of the things he's learned. He went in with a good knowledge of international relations, economics, and finance, so he only picked up some rather esoteric things in those disciplines.  In the others, he feels like has an okay base knowledge now.  Here's a quick list of the top takeways:
  • MBAs, in general, are horrible writers and even worse at self-editing.
  • Not all MBAs are math whizzes.  Some really suck at math in fact.
  • Marketing is more important than he thought it was.
  • Strategy is a lot less important than he thought it was.  Execution is the bigger issue.  FLG thinks politicians would do well to learn this lesson.  
  • Nevertheless, you do need a strategy, but keep it short - anything more than a three point plan gets muddled.
  • If you are going to start a business, then go first to the 3 Fs (family, friends, and fools).  If your business will have tangible assets, then a bank loan might work.  If it's intangible, then you'd better 1) be able to sell somebody that your business idea is a world-beater or 2) start scrimping, savings, and stealing. 
  • The way to get rich is with OPM - other people's money.
  • There's a difference between international, multinational, transnational, and global companies.
  • What shortage cost is.
  • FLG finally learned what goodwill is on the balance sheet.  Short answer:  It's how much the company overpaid to buy other companies.
  • Financial statement analysis is really about like a dozen ratios that FLG had already learned.  
  • You can negotiate with foreign governments regarding the tariff rates for your products.
  • What exactly a synthetic bond consists of.
One thing stick outs more than all of these:


FLG has never understood the advice to sock away 3-6 months of living expenses in cash.  Don't get FLG wrong, he gets that you need emergency savings.  A couple of months, maybe three, FLG understood.  But six months always seemed like it came with a huge opportunity costs.  Where exactly do people get that number from?

Well, in one of FLG's classes, the professor argued, based upon how much cash corporations have historically kept on hand relative to revenues, something more like 12 months might be better.  Needless to say, a bunch of FLG's classmates objected.   First, that's a lot to save. Second, keeping that much in cash is expensive.

But then the professor explained how to view that fund, not as an emergency fund, although it is that, but as a catch-all self-insurance fund.  Not just unemployment self-insurance. Once you have that much saved, you can bump up all the deductibles on all the insurance policies you have, and transfer only catastrophic risk onto insurance companies.   So, if it makes sense, only get catastrophic health coverage.  Drop collision coverage.    Never get a warranty ever again.  Etc.  Self-insurance is far cheaper.

FLG has nowhere near that saved. And to be perfectly honest, his personal finances aren't exactly where he'd like them.  He's embarked on a little bit too much consumption smoothing in anticipation of higher earnings following his MBA, which is rational in the abstract but also risky in the particular.  So, he has to find a new job and do a little digging out.   Anyway, the idea of a self-insurance fund makes all the sense in the world, if you can make it happen.

4 comments:

Andrew Stevens said...

I do have an emergency fund even larger than six months of living expenses, closer to twelve. I think of it in the self-insurance way you describe (e.g. I have a $5000 deductible, the largest I could find, on my home insurance and I only have liability with a high deductible on our car, but I can afford to buy a new car with cash if ours gets totaled). Certainly, I never bother with warranties which aren't automatically included in the product.

I also have used it to opportunistically invest earlier than I had otherwise planned, e.g. in 2009 when the markets were way down. (My timing was far from perfect; the markets continued to decline after I jumped in before they started recovering.) I'm not saying I recommend such a thing, but every once in a while the temptation is irresistible.

I did very little consumption smoothing when I was younger on the theory that I couldn't really trust future me to make the money I was expecting.

However, there are a number of things I would prioritize over an emergency fund - getting the full match on your 401(k), paying off any high interest debt (e.g. credit cards), and, if your income is low enough to qualify, fully funding a Roth IRA (assuming you expect to be in a higher tax bracket in retirement and Roth is the way you're going while you qualify). Between maxing out the 401(k) beyond the full employer match, contributing to a 529 for the kids, or a decent emergency fund, I am relatively indifferent. All three are worthy goals and their priority depends a great deal on where your retirement savings are at. I would definitely put the emergency fund above non-tax-advantaged investing.

FLG said...

Andrew:

Agreed that there are other priorities. The professor suggested that #1 should be to eliminate all debt, except a mortgage.

Somebody brought up the pay of credit cards versus contribute to 401k, and he said to figure out the return you get from the company match. If it's lower than the interest on the credit cards, then pay off the credit cards first.

Andrew Stevens said...

Yes, but it's almost always higher than the credit cards since company match is typically 50% or more. If they're really begrudging you on the match (less than 30%), it's possible that credit card debt might be a higher priority.

Student loans are typically lower than mortgages, so I'd throw those in as well as things not to bother getting rid of, until much later in the process.

By the way, I calculate my emergency fund based on living expenses, not salary replacement. I don't have about twelve months of salary replacement in cash, just living expenses. So I'm looking at expenses rather than revenues.

The Ancient said...

Because I have a terrible weakness for paranoid scenarios, I too have an "emergency fund."

I keep some of it in a really big safe in the country. It consists entirely of bullets -- in the most common calibers for handguns and long guns. Beyond that, there are an indefensible number of cigarettes kept in an invisible room in one of the old barns. Come the worst, all this will be tradable. Highly-valued. Passionately desired. Even necessary to survive.

When I'm in full possession of my faculties (which are not unlike faculty office hours), I know this is all a waste. But the rest of time, I figure the post-apocalypse currency of choice is probably going to be smokes. And where it's not, well, I'm said to be the best shot in the county.

P.S. Ma cher femme Le Comtesse de Crepitude takes a different view, and has a preposterously large 401k. But living where we do, I think, If the worst happens, how could it possibly help?

 
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