ERISA requires fiduciaries to demonstrate their procedural prudence. Besides being a legislated and regulated requirement, it also makes good business sense. We can reduce the risk associated with a particular investment decision-making process by incorporating prudent practices — the more practices, the lower the risk. We refer to this in our training as “The Law of Decreasing Risk.”
The Law of Compounding Risk (developed by Robert Porter Lynch) states that complexity increases by double the number of new elements introduced in a business model. For example: The complexity of (1) launching a new product, (2) with a new partner, and (3) in a new location, increases the complexity (and therefore the likelihood of failure) by a factor of 6. The formula would be: (N)(N-1) = compounded risk.
If the Law of Compounding Risk is true, then the opposite — the Law of Decreasing Risk — also should hold true: That complexity (risk) should decrease as we introduce prudent procedures to a decision-making process.
The risk of not meeting a plan sponsor’s goals and objectives proportionally decreases by the number of fiduciary dimensions being employed. For example, the decision-maker who (1) articulates the plan’s goals and objectives, (2) clearly communicates a strategy to meet the goals and objectives, and (3) employs prudent experts to implement the strategy can substantially reduce the risks associated with the strategy by two-thirds. The formula would be: (N-1)/ N = decreased risk.
Don Trone, GFS® is the founder and CEO of 3ethos, and the co-author of LeaderMetrics®: What key decision-makers need to know when serving in a critical leadership role, which will be released Sept. 15, 2014.
