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Why Redundancy is Your Financial Best Friend: Strategies from the Engineering World

Why Redundancy is Your Financial Best Friend: Strategies from the Engineering World

July 14, 2023

In the world of engineering, redundancy is a critical concept that ensures systems can withstand failures and continue to operate effectively. In this context, redundancy refers to the inclusion of extra components or systems that can take over in case of failure or malfunction, ensuring continued functionality and increased reliability.

By developing an understanding of this principle as a general mental model, we can expand its application outside of engineering (for example - no surprise here – to developing robust financial strategies). Let’s explore the engineering concept of redundancy to highlight how, contrary to popular belief, redundancy doesn’t necessarily lead to inefficiency; it can enhance efficiency without compromising stability.

Avoid Catastrophic Failure

At its simplest, engineering’s version of redundancy involves incorporating extra components or systems into a design to increase reliability and reduce the risk of failure. Essentially, redundancy is about building backup systems that can take over if the primary system fails.

There are different types of redundancy, including:

  • Dissimilar redundancy: Different types of things are used as backup systems, to avoid backups suffering the same error as the primary
  • Geographic redundancy: Physical spaces are varied so that harmful events in one space don't affect the other
  • Hardware redundancy: This involves duplicating critical components or systems in a design. For example, an aircraft may have more than one engine, or a computer server may have multiple power supplies.
  • Software redundancy: This involves building redundancy into the software of a system. For example, a program may have multiple algorithms that can perform the same task, or it may have multiple copies of critical data stored in different locations.
  • Functional redundancy: This involves designing a system so that it can continue to function even if some of its components fail. For example, a car may have redundant braking systems so that it can still stop even if one of the braking systems fails.

Redundancy is an important principle in engineering because it helps to ensure the safety and reliability of critical systems. By building redundancy into a system, engineers can reduce the risk of catastrophic failure and increase the system's overall resilience. 

Critical Systems: Engineering Problems vs Statistical Problems

It can sometimes be tempting to view business, operations, and money purely through the lens of statistics and efficiency; that’s the world of large sample sizes, trends, and averages. In practice, however, many situations involve a relevant sample size of “1” or very few. In other words, your outcome may be one of many in the world, but it’s not one of many repetitions to you. You only get one accumulation period as you approach retirement, and only one first year of retirement, for example. For 100 people, a failure rate of 1% may seem rare and thus acceptable, but for the 1 person who fails, the internal failure rate is 100%, and the 99% of external successes provide little comfort.

A business that runs out of liquidity and is forced to close up shop can't just make it up the next year, "on average" - they won't be operating anymore. Just like a hospital patient can't take advantage of their breathing apparatus tomorrow, when the power comes back on.

This makes financial planning a lot more like a critical system that needs to be designed to avoid unacceptable outcomes than an analyst’s approach to averages and group outcomes. It may help to think of it more like hospital equipment or the airplane you’re riding on (engineering problems) than like the casino’s approach to the next 10,000 spins of the roulette wheel (statistical problems). Some things are ok if they “should” work out, in general, most of the time, over time. Critical systems are not those things, and it’s appropriate to plan for them differently.


Redundancy vs Efficiency 

Though business consulting circles may not always acknowledge it, redundancy and efficiency are not necessarily opposites. Redundancy can be used to improve efficiency in some cases. For example, having a backup power supply can help to ensure that a system remains functional even if the primary power supply fails. This can improve overall operational efficiency by preventing downtime and lost productivity. One can easily imagine why an airline might more efficiently produce revenue and profits over time when its planes don't crash very often, even though safer planes with multiple engines cost more to build and (from an inappropriately narrow point of view) decrease margins.

Similarly, cash and emergency funds can make a holistic portfolio more rather than less efficient in cases where unavoidable expenses come from a “backup system” instead of drawing down risk assets at inopportune times, or in cases where dry powder allows assets to be acquired at opportune times.

Of course, redundancy can also lead to inefficiency, too. For example, having multiple copies of the same data involves storage and maintenance costs. This can sometimes lead to confusion and errors, as people may not be sure which version of the data is the most current. Redundant entry of data requires additional time, and introduces new possible entry points for error, which can have additional costs to clean up. In finances, not being aware of multiple holdings across accounts that unintentionally serve the same purpose or have substantial overlap can be a form of inefficiency and unidentified risk.

Ultimately, whether redundancy is efficient or not depends on the specific situation. In some cases, redundancy can be a valuable tool for preserving critical systems and increasing the efficiency of a whole system. In other cases, it may be the result of poor design, or at least may lead to costs that don’t justify the benefits. In financial planning, we see plenty of both. It’s important to carefully consider the costs and benefits of redundancy before implementing it in any system. 


Yes, Redundancy Has Costs 

Of course, redundancy almost always has a cost. Backup power supplies and multiple engines clearly cost more than the solo alternative. Backup plans for access to money, like home insurance, have a pure cost in the form of premium. Even having multiple sources of income might mean working more hours or developing more systems to manage a business. And having multiple types of uncorrelated investments can sometimes mean paying more fees or hedging returns. 

However, the benefits of well-engineered redundancy can be intentionally designed to outweigh those costs. In our view, long-term success and returns are best viewed as the result of the ability to continue your financial operations uninterrupted. The winning mindset that commits to planned redundancy is, as Morgan Housel has described it in The Psychology of Money, “optimistic about the future, but paranoid about what will prevent you from getting to the future.”  

By building redundancy into your financial plan, you can help to protect yourself from critical system failure and improve your chances of achieving your own unique financial goals by staying consistently and predictably in the game.