INVESTMENT

Horses, tractors and markets


Growing up on a cattle farm in Central Texas, I have built a certain respect for the tools of the trade. Horses, tractors, trucks, trailers, baling wire and duct tape were all everyday items for us.

Each tool certainly has its purpose and each tool has advantages and disadvantages for a specific task. Take the contrast between horses and tractors, for example.

As you can imagine, you can do a lot with a tractor. You can plow a field, fix a fence, pick straw. But the best thing about a tractor is that you can get up every morning and turn it on, do your work, come home and turn it off. As long as it has fuel it will do whatever it tells you to do.

You can do a lot with a horse. Horses have many advantages, such as getting to that difficult place on your land. Their agility makes them especially good at keeping other animals. But horses are bigger and stronger than us and not like tractors, they have their own minds. If you wake up to a horse who has decided he’s not going to work today, you really can’t do much about it!

One of the biggest mistakes investors make – especially professional investors – is to treat the financial market like a tractor. They hope to wake up every day with a reliable and consistent tool that helps them achieve their financial goals. “As long as we keep this tractor well filled with oil, maintenance and diesel,” says Thought, “it will continue to bring us closer to our goal.”

But in my experience, the financial market is a lot like a horse. They have their own minds and they are bigger and stronger than us! Sure you can do a lot with the market, but there are some days that they will shut you down as soon as you get your work done.

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To be fair to my professional colleagues, economic theory presents the financial market as if they were tractors. By bringing the world down into the equation, it’s easy to get caught up in the thought that the market Is The equation – X. Yes, And Comes out reliably. Equations can help us better understand the relationships between variables, but they do not bring us closer to controlling the market mind. After all, all our economic equations have a strong horse bridle – useful and helpful, but not the final word.

And anyone who spends time around horses will tell you: Always treat a strong horse with respect – whether married or not.

2020 is a perfect example. A recent 60% stock has almost doubled the long-term average of the 40% bond portfolio. For the people within a few years of their goal, 2020 has given them a wild swing in their ability to achieve. As you can see from the chart below, a 0-year-old has seen their chances of reaching the retirement swing between 56% to 35% – about 21 percentage points! In contrast, the 25-year-old saw them sway by just five percentage points by 2020.


Possibility of achieving goals according to age

A chart showing the likelihood of achieving goals by age

The same market and portfolio yields vastly different results in the lives of different people with different goals.

This is certainly the effect for which the glide-path portfolio seeks to compensate. Glide-path portfolios, however, are a sensitive way to handle this real risk. Instead of directly addressing the risk of failing to achieve goals, glide-path funds sacrifice more and more for sound instability when achieving goals.

It’s like buying smaller and smaller horses as you get older. Sure they can’t kick hard, but they also do quite a bit of work.

Instead of tackling the “sort” with the risks we think about, why not keep it in mind? It would be better to calculate for the specific variables inherent in each goal – current assets, time horizons and required assets – and a couple with some market strategies. Depending on individual goal parameters, risk control can be an effective way to improve our chances of achieving our goals.

At this point, I hear from my “market-is-tractor” colleagues that low-quality risk control standards achieve lower performance than a benchmark. It could be very good. But “beating the benchmark” is not the goal of goal-oriented investors-to achieve their financial goals. In that context, negative risk controls can not only be a psychological comfort, they can be mathematically rational.

Tiles for SBBI summary version

In the end, investors of all stripes can always move away from the market image as a collaborative tool that does what we do when we need to. As CFA, Jean LP Brunel once mentioned, there are some valuable institutional investors who can be real value makers. The rest of us must be satisfied as price takers.

That means markets are much more like horses than tractors: they are bigger and stronger than us and if they decide to kick our teeth one day, all we can really do is get out of the way.

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All posts are the author’s opinion. As such, they should not be construed as investment advice, or the opinions expressed must not reflect the views of the CFA Institute or the author’s employer.

Photo Credit: © Getty Images / Gayle Shotlander

Franklin J. Parker, CFA

Franklin J. Parker, CFA, founder and chief investment officer of Dallas Direction Advisors. He is a CFA charterholder, international speaker and author of numerous peer-reviewed papers and articles. In 2017, Parker was awarded the NAAIM Founder Award for investment research in integrating active investment management and goal-oriented investment. Although raised on a family cattle farm in Central Texas, Parker now lives in Dallas with his wife and three children.



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