I would like to congratulate Quick Lunar Cop, Mitch and Brian for winning the 500th post prizes. Since there were several Brian’s that entered, I have emailed all the winners. Congrats! Enjoy the prize.

Although this post falls primarily in the entrepreneurship category, if you are investor of public or private businesses, the following are some factors to think about as well when you are making your investment decisions.

In the next 15 years, it is estimated over 9 million businesses run by baby boomers will have to sell their business. The question for these entrepreneurs comes down to “how much?” For most entrepreneurs, their largest asset is their business. Unlike publicly traded stock, there is no readily available valuation for the business. Thus, it is important that most entrepreneurs think about how to increase the value of their business early and often even if they have no desire to sell now. After all, increased valuation helps in attracting good employees and obtaining capital.

While there is no set formula for increasing business value (despite what the experts may say), there are 5 things that you can do to increase valuation:

Think bottom line (profit) and not top line (revenue). I once met an entrepreneur who had consistently run every expense they could through the business. When they decided to seek financing for a new venture, the bank saw a terrible bottom line and refused to provide financing. They wondered how this person could survive for so long on such thin margins!

Beside the obvious audit risk of running up expenses, focusing on revenue over profit, in the medium to long term, typically results in a business with little cash on hand, poor cash flow management and less than ideal valuation. Even if you are not thinking of selling, this type of practice leads to a weekly grind to pay the bills. As for paying more tax on profits, paying tax does mean you are making money which is not altogether a bad thing.

Finally since people purchase businesses on multiples of earnings and rarely on revenue, high revenue growth without correspondingly growth in profits means less money on exit.

Create a unique value proposition. In 2003, PriceWaterhouseCoopers found that goodwill (an intangible asset such as a brand or reputation) represented 74% of the average purchase price of a business purchased in the U.S. Think about that for a second. People buy based on the reputation you have built and not necessarily you having the best product or service.

The foundation of a good reputation stating your unique value proposition- something that differentiates you from the competition- and carrying this through every aspect of your organization.

Think about Apple. It makes cool stuff. Its not really a computer company anymore (they dropped the ending “computers”  in their name several years ago) but a consumer goods company fusing technology with leading edge designs. Their goods look cool. Their stores are a sight to behold and they associate with leading edge people (no one had really heard of Feist in the mainstream before those 1-2-3-4 ads).

A unique value proposition is not just some cliche (trustworthy, reliable, we care about you) but a true differentiating factor from your competition. If you read profiles of top 100 fastest growing companies, the businesses on the top of those lists have a similar element- they express whatever they do passionately and it carries forward from owner to the newest employee.

Unique value propositions can take up entire books but for everyone- entrepreneur and employee alike- ask yourself this question, what is your edge and does it consistently follow through in your life?

Keep the books and financials clean. Off-balance sheet transactions, multiple related party transactions, transactions with valuation concerns, multiple notes in the financial statements- these all create the impression you are trying to juice the books. Banks tend to do double-takes in refinancing and start asking lots of questions. Potential purchasers think you are hiding something.  There are many book-keeping/accounting entries which are conventional (in and out transactions, inter-company dividends, debt to equity conversions by shareholders) but when you start doing the unconventional, it raises a concern. To use a real life example, too many financial wizardry got the financial industry in trouble and it would to your business as well.

Do you pass the test- if you went on vacation, could your business survive? If you honestly answer no, you have created yourself a job, which is fine if you are a life-style entrepreneur. But if your goal is to create something greater than you and you answered no, its time to think automation and investing in human capital. Its a huge leap of faith but purchasers and financial institutions tend to discount goodwill if its too vested in the owner-manager(s) personally.

A good place to start to untangle an over reliance on the managers it the e-myth series. The thesis of the whole series is that owners act too much like technicians and not enough like managers. My advice- find a marketer, a technician and a builder. If you have all three skill sets and can juggle the tension in all three, you have built a good team.

Can your business survive a stress test? Take away your largest customer (ideally not more than 15% of revenue). Increase the cost of capital by 10%. Assume the currency exchange rate works against you if you are in import/export. Can your business survive? Remember these are the same questions that banks, employees and potential buyers are going to ask. If the answer is yes because you have cash on hand, dominate a growing market niche and have management depth, then you are on the right track.

There is no fool proof way to grow a business but the above are some things to consider. Good luck.

Just a reminder that today is the last day to enter the contest to win free stuff. All you have to do is post a comment on this post.  Your odds of winning are pretty good. Entries end at 9:00 EST (to be fair to PST readers)

I have often described a lawyer’s job function as:  “someone you hire to say what you want but can’t and do what you want but won’t.” On some level, lawyers, and other people who negotiate for a living, are blunt instruments for what needs to be done. Get a deal completed while having the other side not hate you (too much) at the end.

Lawyers are expensive though. Same with accountants (if you have a dispute with the tax authorities), real estate agents or other professionals who negotiate for you. Thus, the question becomes when do you hire help and how do you use them?

On one extreme, one should seriously consider hiring help for negotiations which are extremely technical in nature or for subject areas in which you have little to no experience (e.g. buying your first home). In such cases, feeling your way around is not a very practical manner to obtain a good deal.

On the other extreme, subject areas which are quite general (e.g. buying a used chair from Craig’s List) or negotiations for subject matters you have entered into multiple times may not require help or the help is hired only to paper the transaction over once the primary business terms are negotiated. For example, I am not sure it makes much sense for a seasoned real estate investor to use a real estate agent to negotiate terms; they probably have conducted more analysis than the agent and know what their deal parameters are.  Associates for law firms who represent big corporations often view their position as more bureaucratic than deal-making since their clients are so sophisticated that they require little to no business advice and the instructions are often “just paper this over.”

The question of how you use your hired talent is just as important as whether to hire that help. My general observation is that few people use their professionals effectively because they have little to no experience.  The result is that there is an abdication of responsibility which can result in two negative consequences: (i) the professional negotiates the deal in a manner they want rather than what you want (the typical example would be a real estate agent pushing up the top price a client may be willing to buy a property for); or (ii) the professional racks up large fees by not working efficiently (the typical example are lawyers who over-staff files and do a lot of un-necessary work on a file).

By no means am I suggesting professionals are out to plunder their clients in fees and commissions. Instead, let us remember that everyone needs to make a living and you cannot expect someone to provide value without paying for it. The question is whether what you are paying for falls under the category of value or is  unnecessary.

More often than not, unnecessary fees are caused by both sides. In my experience, clients often come unprepared with what they want or the instructions are not clear. A lot of “feeling your way around” ensues which costs time and money.

To give you an example, pretend you want to purchase a home. If the real estate agent asks you: “what do you want to buy?” the answer cannot simply by “something cheap.” It has to be more specific as to area, price range, new/fixer-upper and then you have to adjust and continue to give instructions. If the agent is not following instructions which are reasonable, they may not be the agent for you. But if there are no instructions as to the upper limit you are willing to buy, can you blame the agent for negotiating a purchase which is too steep if the instructions are “we are willing to go as high as we feel is right”?

Granted, since I am a lawyer by training, I have first hand experience of what constitutes a good use of hiring professionals having been hired effectively and ineffectively in the past. To give you an example of how I use a professional, when I purchased a home, I gave my real estate agent a 2 page memo of what I wanted (price, area, how many bedrooms, order of priorities, conditions). When we looked at places, I would share with my real estate agent my comments which I had placed in an excel spreadsheet indicating what I liked and did not like in the places we saw.

I only saw 12 places. Place 1-5 was to get some feelers. By place 7-8, I had a good sense of what I did not want. By place 9, I had readjusted the memo given what we had seen and instructed my real estate agent to downplay certain criteria and focus on other criteria (I gave up the extra bedroom/home office for location). I ended up purchasing a place I love.

This sounds like a lot of work doesn’t it? It is but, at the end of the day, the real estate agent is not living at my place and paying my mortgage.  I am. What he did do which I found to be of value was review the memo, review the spreadsheets, give me a reality check, conduct due diligence based on the parameters I gave him, did all the leg work and had him negotiate given a specific budget (since I was being paid by the billable hour, time was literally money to me).

By no means is this the absolute best way to use a professional but it made both of us turn our minds to the issue at hand and focus. The key point is that even if you hire professions to negotiate, you have to be active in formulating what you want and don’t want. Good luck.

This sounds like an easy question. But, recently, many advertisements, especially for real estate investments, have begun to tout high rates of return based on compound annual growth rates (CAGR).  What exactly is CAGR and is listing CAGR a deceptive manner of measuring return on investment?

The traditional metric for measuring return is based on the growth of net asset value (NAV). For mutual funds and exchange traded funds (ETF), NAV is calculated as (market value of investments + cash or cash equivalents- liabilities)/total number of shares outstanding. NAV is also an important calculation in non-GAAP friendly business such as real estate or service based business where the intrinsic value of the business is found in goodwill or brand value.

For example, assume you purchase a mutual fund or ETF at $10.00. A year later, your mutual fund or ETF is worth $11.00 a share and 3 years after acquisition date the mutual fund or ETF is worth $14.00. Your 1 year return would 10% and your 3 year return would be 13.3% per annum or 40%.

CAGR is a metric that smooths out the annual return over the time the investment is held. CAGR is calculated by the formula: (value at end of time horizon/value at beginning of time horizon) square root of (1/# of years invested) – 1. More simply, there are CAGR calculators on the web. In plain English, what CAGR is doing is assuming that your investment returns at the same rate for every year you held an investment. Using the same example above, your CAGR is 11.87% which dampens the return in year 2 and 3 by balancing the more modest return in year 1.

Why is CAGR used?

In the real estate investment context, where the exit of a project may be many years away and there may not be a readily available market to sell the investment before exit, CAGR is a valuable tool to measure the opportunity costs versus other investments assuming the same time period is used. The same benefit applies outside the real estate context but CAGR works best for appreciation plays with long-term exits and little to no chance of exit before then. Of course, this means CAGR is limited as a hindsight analytical metric.

For the mutual fund and ETF industry, CAGR can be used as a marketing tool to distort risk analysis. Since CAGR smooths out performance, it removes, viewed purely as a ROI number, the ups and downs in most investments. I would not call the financial services industry using CAGR as a return metric deceptive. Instead, what it is trying to do, for better or worse, is to remove emotions out of our decision making process.

For example, in a market that performs poorly one year and well the next, such as 2008 and 2009, a cursory look at CAGR may give the impression to a potential investor that the mutual fund or ETF has steadily done well and would be a buy. Instead, what CAGR hides, or mitigates the impact of, is that huge negative return in 2008.

As an illustration, let’s assume I purchased a ETF at $10.00 on September 28, 2007. On the one year anniversary of my purchase (i.e. approximately 2 weeks after Lehman Brothers collapsed), that same ETF  traded at $6.50. Today, I sell that ETF at $11.50. This means my CAGR over the course of my investment is 7.24% which is an extremely respectable return.

Here’s the catch though: how many of us would have held on to this fictional ETF in 2008? Studies show that the average investor performs poorly because they cannot rein in their emotions by riding out market lows or leaping in during the highs. The financial services industry is not stupid and knows that the easiest way to market is to post a CAGR figure rather than have the potential investor mull the big negative numbers (by law, mutual funds must disclose 1,3, 5, 10 year and since inspection returns- CAGR is not a required disclosure).

The point is this: CAGR is a useful tool for comparative analysis and for certain types of product as long as the same time period is being used. But,  an over-reliance on CAGR ignores two fundamental realities of day to day investing:

1. The past does not predict the future and substantially relying on past performance as a decision making criteria is dangerous; and
2. CAGR ignores the fact that investors invest with emotions and, in addition to smoothing out performance, it assumes we can all maintain even keel during the period we hold an investment.

The key is not only to look at CAGR in and of itself but how it was derived and whether you would have the emotional control to hold onto the investment during the worst periods.

Under the law of unintended consequences, there are two developments that may actually doom the exchange traded fund market to mutual fund-itis. As reported by Preet previously, regulators in various jurisdictions are proposing to eliminate mutual fund companies from paying commission to investment advisors to secure sales or to accept trailers.

More locally, as of Monday, National Instrument 31-103 (NI 31-103) will be in force across Canada.  NI 31-103 harmonizes the byzantine Canadian securities regulatory when it comes to registering market participants by  requiring anyone who is in the “business” of securities (a wide regulatory net than merely selling securities) to register in one of five classes of registrations.

In particular, those who administer mutual funds will be required to register for the first time ever in a newly created “investment fund manager”  registration class. The compliance requirements will be quite costly as it requires the hiring of compliance officers, registration and policies and procedures (both new and updating of old ones) to be implemented.

Both the move to disclose or limit mutual fund commissions and trailers and to require greater registration commenced in 2006. The results, as a whole, can be seen as a pincer movement on the mutual fund industry. On the one hand, regulators are  trying to slow revenue growth by  limiting enticements to push product and, on the other hand, increasing expenses through more compliance measures (undoubtedly, NI 31-103 has cousins in other countries).

Regulation alone has never stopped the financial services industry; history shows that as soon as the regulators close down one loophole, the player move to a greenfield product that has little to no regulation and it takes the regulators years to create another regulatory framework. If not for the credit crisis, Congress would still be talking about how to regulate hedge funds.  More to the point, while regulators are adding regulation to mutual funds, lawmakers are scratching their head over how to limit commodity ETF that may be distorting market prices.

Thus, the fact you have the regulators protecting the public interest in product that is most likely on a downward side of a product life cycle  (although very slow decline) while Congress scratches its heads about the public policy consequences of  ETFs  (“….Mr.  Speaker, I thought ETF was a branch of the Department of Homeland Security…),  means that the industry may move away from the regulators to something they don’t quite understand yet and has legs. This is the ETF market.

I do not think regulatory pressure on the mutual fund industry alone will cause a wholesale shift to the ETF market. But it will be a factor (the degree of influence is up for debate). If this happens, history indicates that the financial industry will basically ruin ETFs with excess and sell the sizzle and forget the steak.

Sadly, excess is already here. As Larry MacDonald reported, there are now actively traded, non-benchmarked, high MER ETFs on the market based on demographic trending (the 1.96% annual operating expense seems low given the prospectus states underlying ETF fees and expense are 0.17%; if turn-over is high, this seems like a low estimate). Given 1 million units were traded in the first 4 days of trading- a relatively modest volume given that Vanguard Total Stock ETF traded almost 1.9 million shares yesterday-it seems to prove the theory people will buy anything if packaged right.

As a smart investor, if poorly designed EFTs becomes the rule rather than the exception, please remember why you would invest in these products to begin with, mainly:

1. You have no intention to beat the market which, statistically speaking, will not happen to most investors but matching the market will put you in a better position than most active investors;
2. Broad exposure to markets; and
3. Low fees.

If a new mutual fund, dressed up in ETF clothing for sales and regulatory purposes, is pitched to you, please review the above list and see if it passes the test.

If you are a regular reader of the money gardener, you will notice that his monthly net worth updates include the ratio of house value/total assets. In essence, he is attempting to assess whether he’s overly exposed to real estate. After all, one of the lessons from the credit crisis is that too many people relied upon the paper gains of an appreciating real estate market  and got over-confident. But the question is, if you don’t want to make the same mistake twice, do you own too much house?

First, let’s deal with valuation. I asked money gardener how he valued his home and he indicated he made a “conservative” valuation based on comparative sale prices of his neighbors’ homes. I understand that he lives in a neighborhood that is relatively homogeneous in terms of size of lot, square footage etc. with sales in regular intervals. Thus, he was more or less conducting an apples to apples comparison with current data.

The issue always is what happens if you live in a unique (not in your own mind but to the buyer’s) house/property or the comparable data is quite dated (i.e. more than 12 months ago). At that point, you have a couple of possible options: (i) find the last comparable sale price and add in appreciation based only on the rate of inflation (unless your area got wiped out when the housing bubble burst); or (ii) find a comparable as close as possible and use that valuation. The point is never to “add” anything to what the market shows you and to aim low rather than high if in doubt. For example, in the event you have an upside down mortgage, I would, sadly, use that appraised rather than acquisition price.

Assuming your valuation skills are a little bit better than how rating agencies rated corporate debt circa 2005-2007, what is an ideal ratio of house value/total assets? In the abstract, both money gardener and I agree that anything in the 75%-80% range and above would be over-weight in real estate and is simply too many eggs in one basket.

I would add two wrinkles though. If you are a first time home buyer or have bought your house less than 2-3 years ago, a high house value/total asset ratio is simply a reflection of your reality that you used a lot of your assets to purchase your home. The key in this situation is to make sure the ratio is not extremely high (90% plus), you didn’t buy the best house in the worst neighborhood and, post purchase, to ensure that your house value/total asset ratio continues to decline steadily year over year.

Typically, this would mean adding assets which generally move opposite to housing values. Since housing is considered by some as a consumer discretionary purchase, one would try to balance it out with consumer staples, assets that don’t decline as much in a downturn (gold may be a possibility but its value as an investment is up for debate), plain old cash (since house valuations are paper gains), dividend yield stocks not in real estate (again, dividends are cash in the bank).

The second wrinkle is to add REITs and real estate stocks as part of your house value since, to state the obvious, REITs and real estate stocks tend to mirror the real estate market as a whole (even though the commercial REIT market tends to react about 12-18 months after the residential housing market as seen by rising commercial vacancy rates in North America).

The notable exception to a high house value/total assets ratio is if you hold many real estate investment properties. In this situation, a higher ratio may be warranted (emphasis on “may”) assuming the properties are in the aggregate cash flow positive, the local vacancy rate for the type of investment property is relatively low and there is a sufficient cash reserve built up to weather against vacancies. In this case, one would assume that the real estate investor is quite competent; expertise and positive cash flow management would mitigate against a diversification strategy.

Special thanks to money gardener for contributing to this post.

TMW has reached 500 posts! A special thanks for all of you who read daily, the other bloggers who link to my posts, advertisers and people who have given my tips and suggestions.

As a token of thanks, I am giving away one copy of Kerry Taylor’s (aka Squawkfox to the blogging world) 397 ways to Save Money showing you ways to save money on your home, insurance, pets and other simple and effective ways to make your dollar go further.

Prize #2 is David Bach’s Fight for Your Money. As the by-line says:  The bestselling author shows you how to protect your money and put thousands back in your pocket every year by taking on the “corporate machines” who are taking you to the cleaners.

Prize #3 is David Krueger and John David Mann’s The Secret Language of Money: How to make smarter financial decision and live a richer life; a book which explores our subconscious meanings to money and how we can change our habits. I will be reviewing this book in a future post.

All you have to do is post a simple comment. I will do a random draw at 5:00 pm (EST) next Tuesday and announce three winners on Wednesday. The first winner to respond gets to make their pick, the second winner to respond chooses next and then the third winner gets the remaining book.

Back to regular programming tomorrow.

Fundamentally, all wills should start with the question of who takes care of your estate and minor children before moving on to what the estate is giving to whom. Who acts as  executor(s) (referred to as estate trustee or liquidator in some jurisdictions) and guardian(s) for children (both custody and property) can be critical decisions which need to be made for the well-being of your family after your death.

Typically, most wills set out that the residue of the estate (the portion remaining after your estate has paid all funeral expenses, taxes and debt) is transferred to the surviving spouse who also, in most cases, continues to be maintain custody and are guardians of property for minor children.  But what happens when both parents/spouses pass away?

The following is some information to consider when making these decisions. As usual, please consult a qualified lawyer for advice specific to you.

Choosing an Executor

The estate (which is what your possessions and debts are called after your death) must be administered by someone in this scenario. To be clear, the executor does not have to physically carry out all the steps necessary to carry out the wishes of your will. A well-drafted will grants to the executor the ability to retain professionals to assist the executor in doing so.

For most uncomplicated estates, some options for the executor’s role would include siblings who live close to the deceased, a close family friend or the family’s lawyer or a combination of these people (most jurisdictions allow you to have multiple executors). Generally, siblings or friends who live in far-off places, elderly parents and distant relatives tend not to be good options. The other factor to consider is if siblings and non-elderly parents become guardians of young children, would you what to burden them with additional responsibilities? The compromise in this case may be to appoint multiple executors and/or separate guardians for the children.

For the complicated estates (self-employed individuals with businesses to tend to, estates with property in multiple jurisdictions, large estates, many beneficiaries), the question becomes not just appointing a sibling, close friend or family lawyer but whether these individuals have the time, knowledge and skill-set to administer a complicated estate (remember that both spouses are deceased so there is little family memory to rely upon).

For many executors of owner-managers, they may end up having to make key decisions for the business for a period of time before the business is handed off to children who come of age or sold to third parties. Thus, it is doubly important to ensure the executor lives close the deceased and the business and understands how to operate a business.

As a result, many people with complicated estates end up choosing a sibling or friend with professional qualifications, even if they are closer to another sibling or friend or a lawyer (and care must be given on whether the lawyer herself is of an age that they may predecease you or retire before your death) or a trust company (a very costly last resort).

Choosing a Guardian

As a crash course on children’s law in Ontario, the appointment of a guardian for a child’s property and the person obtaining custody have 90 days after death to act in such capacities and must apply to the Courts to continue both custody and guardian of a child’s property after this period.  The Courts typically defer to the wishes of the will unless the guardian is unsuitable for the position. Please note that if you have joint custody of a child, awarding custody or guardianship of a child’s property is invalid for the obvious reason the other person having custody of the child has a say.

The question of guardianship is much more emotionally vested than that of an executor since it becomes a question of who can meet the emotional needs of a child as well as managing money properly (either money given to the minor child in trust or to the guardian) given both parents are deceased.

Nonetheless, the same practical considerations exist: is the guardian close by (unless you do not object to moving your children), are the guardians of the same relative age or younger than the deceased when the will was drafted (a 72 year grandparent obtaining custody of a 10 year old child is most likely unfair to both parties), are the guardians suitable parents?

It is possible to appoint joint guardians. Thus, your brother and sister-in-law could be wonderful parents but terrible at money. In which case, it may be prudent to appoint your other sibling who is good with money to be guardian of your child’s property to ensure any money they inherit will be invested wisely. For people who appoint a married couple as guardians, the risk is always the couple is divorced or separated when they are supposed to take custody. Thus, many lawyers ask their clients to only appoint the more appropriate person among the couple.

Should the Executor and Guardian be the same person?

It depends. Technically, most jurisdictions have no prohibitions against the executor and guardian being the same person. However,  a complicated estate can literally take years to close. In such a case, do you want your guardian to focus on taking care of the children and providing a loving environment without the “distraction” of making multiple decisions about the estate (especially if the guardian is fit to be a parent but not necessarily the best money manager)?

The analysis becomes contextually. For example, some people with larger estates, uncomplicated or not, like to split the functions to create checks and balances. The guardian will want to maximize the residue of the estate for the children (assuming they are inheriting the bulk of the estate) and will keep a close eye on how the executor is using the estate’s resources.

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These are all difficult questions with no easy answers. Thus, even the most ardent of DIY’ers should seek legal advice for their situation. Good luck.

I am breaking my union rules by posting on a Friday. But with the one year anniversary of the Lehman Brothers collapse this week, I thought it would be an opportune time to reflect back. Jonathon Chevreau had an interesting post last week about seven lesons from the meltdown which should be required reading. One of the more eye-opening pieces on the fall of Lehman Brothers comes from an article in Esquire outlining the fight between Barclays and JP MorganChase over the salvageable parts of Lehman Brothers and how the JP MorganChase attempted to short Barclays, oh, $7 billion (best quote from the article: “JPMorgan doesn’t want to save the universe… JPMorgan wants to profit from the destruction of the universe.”).

Watching a bunch of capitalist titans battle it out over billions of dollars is interesting but not very practical for our day to day lives.  Thus, on this most surreal of anniversary weeks, I suggest something more manageable. We, collectively, have short memories which makes us bad investors. So, here’s an exercise for you. Write down the 3 things you learned from this past year investing in turbulent times. Post it somewhere where you can see it every single day until the lesson is not lost to you. I picked 3 since it is a number you can wrap your head around. You get to 5 or 10 and its too daunting.

Here are mine:

1. Be cautious but don’t be a downer. I missed Saputo. Again. Thought about buying it at $19/share and blinked. Again. Worried about the other shoe dropping on the economy. Worried about cheese prices. Worried about the lack of cash on its balance sheet having acquired a bunch of companies. It now trades slightly over $26. The lawyer in me keeps seeing worst case scenario but there’s a different between being a prudent investor and Little Mr. No Upside.
2. Stop checking prices ever day. This is self-explanatory. It will give you an ulcer.
3. Focus, focus, focus. This is more to do with running a business but it is easy to be distracted and not finish something you started. For personal finance, if you wish to pay down debt, then do it. Don’t stop halfway and then change course.

Have a great weekend. As a heads up, I giving away stuff next week in celebration of post # 500.

Stock markets tend to be used by some as proxies for the state of the general economy given it is a readily and easily available source of information to rely upon where the “score” is kept daily. But is this really a good barometer of our economic health?  The answer is most likely not.

As Canadian Financial DIY wrote about recently, there appears to be no relationship between a country’s GDP growth and stock market returns and, in fact, there may actually be an inverse relationship between economic growth and stock market return. Assuming the studies are right, cheering for the NYSE or TSX to keep going up may actually provide small solace to you and I (and so much for investing in your BRIC ETFs).

The explanation is manifold. Foremost, publicly traded companies have a very narrow band of stake-holders. In essence, they are built to serve the insiders, shareholders, bond-holders/lenders. Full stop. As a result, the wealth of a publicly traded company is spread rather thinly among a small band of the population.

How small? The Federal Reserve’s study “Changes in U.S. Finances from 2004 to 2007: Evidence from the Survey of Consumer Finances” found 17.9% of American households surveyed owned stocks, 15.9% of American households surveyed owned pooled investment funds and 34.6% owned retirement accounts in 2007 (I am assuming stocks would be kept in those accounts and the 17.9% references stocks held outside retirement accounts).

Thus, the ubiquity of conversations about stocks in personal finance blogs masks the fact a minority of households actually own stocks and any gain in the stock market is beneficial to a small subset of the population.

In comparison, collective GDP growth is, obviously, an aggregate of publicly traded companies, private companies, public sector and consumption growth which is much broader in scope. Since private companies are not subject to the same disclosure requirements as their public counterparts, it is always hard for the media to speak about private companies. But, if you worked for such large private concerns as Koch Industries or the Jim Pattison Group of companies, you would know first-hand that private companies are just as productive and profitable as any enterprise.

If there truly is a disconnect between the stock market and the economy, there are several implications going forward:

1. Blindly buying stocks in emerging economies may not be a prudent strategy. Many emerging businesses in emerging countries (and let’s assume in emerging economies the stock exchange is also not very mature and established) tend to be private or partially or wholly government owned (see Saudi Aramco, Petrobras, Huawei). Thus, GDP growth may actually be going into government coffers or into private hands and not to shareholders of publicly traded companies.
2. Experts may mistime calling an economic recovery simply by looking at the stock market. In other words, it is not enough to look at the headline but why people think the recovery is here.
3. Market gains = social strife? In the mid-1990′s, many people began to voice concern that publicly traded companies, especially banks, were making billions in profits while a jobless recovery was occurring. If the market continues to trend up, the dialogue could shift from the stability of the financial system to what, if any, social responsibility publicly traded companies have especially, unlike the 1990′s, taxpayer money was used to bail out many publicly traded businesses. I suspect Michael Moore’s movie about capitalism is the opening salvo in a long war. I don’t know if any bankers read this blog but you may want to dust off the pr hand-book from the mid-1990′s and amend accordingly.

Ever shop for a car and the salesperson puts you in some tiny office with uncomfortable chairs and then asks you to wait while they take the deal to the manager and you wait and wait and wait? It is not that salesperson moves slow or the sales manager can’t make a decision or time moves slower in an auto dealership. It is more likely that they are using deal fatigue against you.

Deal fatigue is a term often used to describe negotiations which tend to drag on and, having lost all patience, one side or the other gives in. Deal fatigue is often a good opportunity for that most despised negotiation tactic- trying to renegotiate or slip in new terms at the last minute (as Squawkfox found out when buying a used car).

A good salesperson aims modest but knows, having spent hours negotiating, you may be more susceptible to agree to something, anything, to get the negotiations over. This is why extended warranties are always sold last- the salesperson knows that few people walk away from a deal over an extended warranty and commissions on extended warranties are higher than the good or service being sold. What good salespeople are really doing is exploiting our innate need in the internet age to seek an expedient rather than a correct solution.

This is why so many labor negotiations are finalized in the wee hours. Both sides are literally tired of one another and, suddenly, those entrenched positions are no longer so entrenched (and in public-sector negotiations, it is not their money anyways so you might as well give away someone else’ farm- see David Miller, exhibit A).

But, let’s turn this around on its head. Remember that deal fatigue is a double-edged sword. Most salespeople work on commissions and the longer you negotiate and may not close the larger the opportunity cost of lost commissions. The absolute worst thing for a salesperson is for hours of negotiations to occur and for you to simply walk away. Thus, the other side may simply cave as well sensing lost commission.

There are a few practical things you can do to avoid having deal fatigue work against you.

1. Never negotiate hungry. Big ticket item negotiations, for cars and houses, can literally take hours. Let your head do the thinking not your stomach.
2. Create an artificial deadline. Indicate that you have an appointment to keep at the beginning of a negotiation and, if you can’t close the deal before the appointment, you will have to leave. Remember good salespeople want two answers: “yes” or “no.” The two worst answers are “maybe” or “let’s talk tomorrow.” The key to this one is to stick to the deadline AND walk away or they know you are bluffing.
3. Tag team the salesperson. Bring someone else along and take turns on issues. You tend to keep fresh and you have a perfect good cop, bad cop set-up.
4. Ask for a life-line. Like the show “Who wants to be a millionaire?” have someone who you can call to give you objective advice in the heat of negotiations (it is also a covenient way to take a break).
5. Simply walk away. It is not a perfect home or the perfect car or the perfect gadget until it is yours. The worst thing in the world is actually not getting what you want but getting what you want- and paying too much for it.