The Investment Drama Triangle

Many of you have likely heard about staying out of someone’s “drama triangle”.  The drama triangle is about having a victim, a savior, and a persecutor and being in a place to change roles when it is convenient for you.  

Unfortunately, the Drama Triangle exists in Investing as well.  That Drama exists among Benchmarks, Timeframes, and Emotions.

Unreasonable Benchmarks:  It is easy for clients to compare their portfolios to the numbers they hear in the media each day.  However, these benchmarks likely are not an accurate reflection of their portfolio. Investors that compare their portfolio to the S&P 500, but aren’t 100% invested in stocks are likely to be disappointed during bull markets.  Additionally, if they are invested in actively managed funds, when you account for the expense and the tax impact, not to mention underperformance risk, you will also likely be disappointed when comparing to the S&P 500.

Unmanaged and Emotional Expectations:  Meb Faber likes to post the assumptions of different generations and various pension funds from time-to-time (you can follow Meb on twitter, @MebFaber).  The expected returns are alarming. If your expectations are not grounded, then your emotional triggers will likely be more sensitive.

Changing Performance Timelines:  Any asset manager can pick a timeframe that makes themselves look good and any investor can pick a timeframe to make an investment look bad.  Using time as a manipulative or selectively biased tool is a great way to add drama to your portfolio.

Anytime you choose to manipulate these corners of the investment drama triangle, you are a/ looking for a problem that may not exist, b/ creating unnecessary anxiety, and c/ likely triggering an action cycle that exacerbates the problem.

The Investment Drama Triangle has triggers that may or may not be initiated by the market.  The Investment Drama Triangle usually has a VUCA catalyst - VUCA is a term that originates from the Army War College. Ann Deaton, PhD, leadership coach, and Author of VUCA Tools for a VUCA World has studied these triggers extensively.  V is for Volatility, U is for Uncertainty, C is for Complexity, and A is for Ambiguity. It is just as likely that VUCA starts from other sources of wealth - your relationships, your experiences, and your time and one of the ways you try to lasso these characteristics is to “do something” with your investments.

Moving from Drama to Control

Several small shifts in mindset in Drama Triangles are necessary, but fortunately, completely in our control:  From Threat to Opportunity, From Reacting to Responding, From Outcome to Process.

First, we need to shift our Attention on the Process Not the Outcome.  When you focus on the process, you move away from problems and events to opportunities to excel.  

Secondly, we need to examine our Intentions to focus on the Plan and not the short-term triggers.  There are a lot of unlikely events that can happen - so many, in fact, that the probability that one (or more) of those unlikely events will happen may be higher than you think - it is important to manage your expectations and how that may affect your investments and your life events and how we can move from reacting to responding.  

Results should enable long-term wealth in the form of relationships, time, and experiences.  This is more likely to happen when you Reflect and Respond rather than emotionally react.  

Dynamic Tension exists between our life goals and our currently reality that fortunately we are in control of when “life happens”.  It requires that we keep moving towards the vision, or realizing how little our current reality impacts the vision. Wallowing in the current reality may be warranted in some cases for a short time, but it likely won’t impact your investments as much as you think.

How do we move from the Investment Drama Triangle?  There are several remedies that have been showcased on the internet for the Traditional Drama Triangle - The Empowerment Triangle and the Compassion Triangle are two examples.  Outside of reading Daniel Crosby’s Book The Behavioral Investor for strategic guidance and Ben Carlson’s Blog at www.awealthofcommonsense.com for daily “therapy”, I would invite you to the Investment Control Triangle.

The Three Points of the Investment Control Triangle:  

Control Your Expectations:  Behavior can be hazardous to your wealth.  Ungrounded expectations can be hazardous to your behavior.  Before any investor acts on expectations, it probably would be smart to make sure their expectations were realistic.

Control Your Benchmarks:  I admit that I look at the S&P500 and compare my portfolio to it - however, I do not have any emotional tie to any disparity between the two.  I also use multiple benchmarks and mixes. This provides the necessary context for me to process performance and understand how goals are still achievable with my mix.  I encourage investors to look at a 75% ACWI/ 25% AGG mix and then a 25% ACWI/75% AGG mix and see if their portfolio falls between those two just for a level set. You can also use other tools to benchmark against your risk rather than your returns.

Control Your Timeframes:  The markets don’t care where the earth is relative to the sun or how many times the earth has gone around the sun.  We have a reasonable idea of what to expect over time, but that is a range not a target. Each goal is likely tied to a timeframe and your advisor should be working with you to determine if the timeframe and the goal is reasonable.

Our news cycle has enough drama and the recent Tweet-a-thon on Trade Relations and the Federal Reserve are providing more fuel to our Investment Drama Triangles.  Here is what 19 months of data and “drama” look like.  

If you take out all those points between the beginning and the end, it comes out to be a 3.4% return on the S&P.  That doesn’t sound dramatic at all. In the meantime, you have had the opportunity to diversify, rebalance, and contribute to make the most of the opportunity rather than wallow in the “problem”.

Getting Away from Investment Noise for the Greater Good

One of my favorite parts of consulting for past colleagues is that it allows me to find the transitive properties between business consulting and investing.  It also allows me more adult interaction and a break from the confines of studying in my office (and I do mean studying).

While I unfortunately spend time away from my family, it does offer me the opportunity to reflect on what I am doing well and what I can improve on after I try to get caught up on client interactions and “studying”.  I typically leave for home with a longer list of “Big Projects” than I expected. It also gives them a break from Daddy Boot Camp.

I really need to just get away with none of my making the donuts activities.

I would never do this if I couldn’t serve my clients at the service level that I expect and they deserve.

I recently turned away a seven figure client because it wasn’t aligned with who I am and what I do, what I offer, and what I can deliver...more on that in a minute.  

When my kids and my life allow me the time to think, there are some things I don’t have to think about.  The principle of using evidence to build low cost, rules-based, data-driven portfolios does not require any thought.  Neither does striving to be better than traditional asset management.  

I spend my time thinking about is how I can help investors see the traditional investing flaws and reduce the threats to their wealth - many self induced.

The last client that I turned down just wanted high dividend holdings and sexy holdings like Facebook, Netflix, and Amazon in their taxable account and wasn’t interested in my perspective on the impact to their taxes or diversification.  They wanted an old-school broker-dealer (she was 91). These are the paradigms that will need to fade away with age.

Many that read this will never become a client - I am only accepting 24 more.  Those that do understand what I offer - a passion for analytics, a pursuit of mapping your risk profile, providing a portfolio that matches your investment plan that minimize emotions and maximize your desired lifestyle with the other areas of your wealth.  

I provide emotional air cover with Dynamic Risk Allocation, I offer tax efficient portfolios, and I offer contribution and distribution strategies, and cost effective holdings.  That value alone should provide you with great structure, the gift of time, and peace of mind. Having a process to offer this and one that clients understand and value - allows me to take vacations and more importantly allows THEM to take vacations - without worry.  My recent vacation through trade tweets and yield curve inversions was restful - no drama, no ego, no worried clients - just a lot of quiet in the Cascades.

I would love to produce 8-12 percent returns every year with the least amount of variation - but that isn’t reality and more importantly it likely isn’t necessary for people to fulfill their unique definition of wealth, so why pursue it with the associated risk.  I love the study of variation. It is one reason I weigh myself every day. The funny part is that many people would prefer the pursuit of 20 percent returns, knowing that it introduces a lot of toxic behaviors and results.

I am yet to walk in a house where people have pictures of themselves at the beach or a ski resort with their 20 dollar bills.

Investment drama is unnecessary, but it is what makes me send the proverbial search and rescue units for the most often on their wealth journey.  

Life experiences should provide excitement, not the stock market.  More importantly, regardless of how badly your kids behave or how spoiled they are, it will be much cheaper literally and emotionally, to go to Disney than to buy a sexy stock.

The Difference Between Managing Money and Managing Wealth

Investment advice without adherence and guard rails that automate and regiment behavior isn’t worth much.  Investment and Financial Planning that enables these good behaviors is worth far more than the price of admission.

Offering a portfolio and an understanding of the levers within your control is how financial planning separates Managing Money and Managing Wealth.  In other words..

Managing Money Managing Wealth

Asset Allocation, Forecasts, Risk Tolerance Asset Location, Expected Returns, Risk Spectrum

Managing Investments Managing Investors

Portfolio Construction Financial Plan Construction

Risk Management Emotion Management

Products Principles, Process, People

Financial Capital Human Capital

Money Experiences, Relationships, and Time

Taxes This Year Taxes Over a Lifetime

Prepares for when markets misbehave Prepares for when life happens

Manages Inflows and Outflows Choreographs Systems, Processes, and Behaviors

Where to invest a lump sum How and when to invest/divest a lump sum

 People lose their $H!t it at poorly timed emotionally triggers...collectively.  It is the behavior driven market cycle. This isn’t a function of cost, it is a function of fear and greed.  Cost effects money - behavior effects wealth much more so.

A portfolio is not, in and of itself, a plan. And a portfolio that isn’t in service to a plan is just a form of speculation; - Nick Murray

Nick is trying to say that the goal can’t be to beat the market.  No plan is built around “outperformance” of a random equity index.  Money is only part of the plan - albeit an important one. A plan involves a portfolio that is calibrated to deliver what the plan calls a reasonable range of expected outcomes over time, that understands the client’s risk capacity and risk required.  It involves dynamic calculations and assumptions to produce probabilities and knowing what levers to pull. Nick Murray continues while discussing the merit of a plan...

Back to Nick...

What it does do is demand rational, deliberate behavior on the part of the investor and his trusted advisor.

Financial planning looks at basis points but doesn’t obsess over them.   Behaviors cost more than a few basis points - sometimes even full percentage points.  Yikes!

Focusing on cost and performance and dividends rather than the holistic plan is like driving 50 miles to save 10 cents a gallon on gasoline.  Deductions, Tax Exempt Muni’s, and other behaviors are worth a lot more when they are tied to a distribution strategy in the plan.

Poor behaviors are price agnostic and are independent of your portfolio.  The plan is what matters most.

How I Rationalize and Reduce Trend Equity Strategy Drawbacks

Trend following attempts to mine and filter irrational participant behavior, but it has challenges itself - specifically whipsaws and rudderless markets that generate false positive reads on the trend.  These false positives, if not managed and understood, can actually create worse behavior by investors. We attempt to mitigate these.

Whipsaws and rudderless markets show up the same way - an unnecessary trade where you sold low and bought higher.  If you go in knowing this will happen from time-to-time, but serves a purpose, it makes it easier to swallow. It’s part of the evidence-based, rules-driven process.

Complement Strategic Trend-Based Asset Allocation with Tactical Trend-Based Risk Allocation

Most trend strategies are binary - all in or all out.  I employ two different approaches. My Strategic approach needs two signals to go risk off - (1) Is the Total Market Index/Aggregate Bond Index Price Ratio Fast Moving Average below the Slow Moving Average, and (2) Is the unemployment rate greater than the three year moving average of the unemployment rate.  If both conditions are met, then the portfolio will swap some equity assets for fixed income assets.

Strategic Approach

Here is an example of all in or all out - no employment filter - the past 10 years.

With a very unattractive risk-return profile - you would leave nearly half the returns on the table.  That is expensive insurance.

However, look at how this changes when you extend the time period to 12.5 years back to February 2007.

This shows that trend following can add value, but we need to filter those false reads in the past 10 years to obtain it.  Doing so would even improve upon this backtest. If we added an unemployment rate filter, this trend could avoid a lot of false reads.

TACTICAL

My Tactical approach identifies an “Offensive” and “Defensive” position.  I still use the Price Ratio between offense and defense, but I am able to capture a lot of downside protection, while still participating on the upside for any false reads and maintain my asset allocation discipline - albeit at a different risk when price behavior suggests.  This different lens allows me to manage and reduce the downside of trend strategies. Here is an example of my Emerging Markets position. By migrating from a binary all in or all out approach to a dynamic offense-defense approach with all asset classes, you add another degree of diversification.

That said, the trend strategy will still not find perfection, just direction.  It is also important to understand the cost of being wrong and how to frame any actions in changing your trend equity position.  You must know the intent and compare that to an emotional and dollar-based cost-benefit and decide if it is worth it.

1. Trend Equity should provide emotional air cover

2. Trend Equity should offer a short-term insurance policy on your portfolio - this insurance policy is the cost of being wrong and that being acceptable compared to the risk experienced over a lifetime.  You have a lot of insurance that you never use. Trend Equity intends to offer insurance against big losses while costing you a little from time to time with no benefit.

3. Does the trend approach of “buy and mold” exceed the value of “buy and hold”.  This can fall anywhere on a spectrum of emotional peace of mind and risk adjusted return.  In either case, client transparency of what you are doing and why you are doing it, should be part of the process that builds the trust in your inputs and outcomes.

Understanding simple, but effective tweaks to trend equity strategies and understanding the purpose and process behind them can make trend equity concept an attractive complement to a passive index approach.

Stop the Moving Targets and the Paradigms with Relative Trend Portfolios

Investing is emotionally charged, thanks to the “power of now” in our lives and our news cycles. This emotional charge leads to poorly rationalized actions with our investments.

Successful Investing, happens when you are noticing what you are noticing. It’s recognizes the polarity between order and chaos; emotional and rational thinking; simple and complex; more and enough. Changing a portfolio without purpose, feels like changing pitchers in a baseball game - it’s the illusion of activity based on a “gut feeling”. Many don’t recognize how similar change rationale in your portfolio may lead to things falling faster than a Jenga skyscraper.

Investing can be like balancing your daughter’s wedding cake while flying cross-country on a commercial airliner. Most of the time, it’s fine - the pilot turns off the fasten seat belt light and you have an on time arrival. But get bounced in any direction by a turn or unexpected turbulence, or hit by the drink cart, or another clueless passenger, and you are screwed. Plus, there are times when there are expected inconveniences - boarding, connections, crowded restaurants, short layovers. Investing has the same complexity and same type of problems - some in our control, and others where we need to be prepared. There are a lot of moving parts that you have to hit perfectly.

The Moving Targets of Investing

How can you expect to be a successful investor when you are aiming at multiple moving targets?

Moving Target 1 - Life happens and goals change or require a new means to achieve them. Job changes, college funding, family size, aging parents are some that we will all face at some time. There are others that are less common, but still may significantly impact your plan.

Moving Target 2 - Markets misbehave - it is what they do. Unfortunately, our human nature results in us handling this behavior quite poorly. It is another change to let our emotions take over, and frankly, we suck at it. We tell our kids all the time that bad behavior doesn’t justify bad behavior - why do we allow ourselves to misbehave with our money.

Moving Target 3 - Your risk profile. The important aspects of risk are (1) what risk is required to enable your goals, and (2) what is the maximum risk you can afford to take without putting your goals in jeopardy, (3) what is your desired risk tolerance - hopefully this falls between the risk required and maximum risk, and (4) what is your risk composure in turbulent markets - this is a sliding scale.

If your risk composure falls between your risk required and maximum risk (some call this risk capacity) you are in a good place. Anything above your risk required is unnecessary risk. Recognize that contributions to your account make you more risk agnostic and distributions makes your account more risk dependent.

How do we confront moving targets in investing?

I use a rules-based, Relative Trend investment strategy that switches the holding within an asset class based on relative price performance. The trend is based on relative price strength between an “offense” and “defense” position. The “offense” position is for when the markets has a more constructive stance. Conversely, the “defense” position is when the markets have risk off tendencies. This relative approach doesn’t necessarily change the asset allocation, just the risk allocation within the asset class. We switch between the two holdings based on market behavior, rather than when the earth orbits the sun. Below is a chart of our strategy in motion with our Domestic Large Cap position.

Here is the difference in each position’s risk profile, courtesy of Riskalyze.

Here is MTUM…

Here is USMV…

Changing between offense and defense has five distinct features over a buy-and-hold approach: (1) Your current 401k is not capable of diversifying like this. Diversification isn’t just about asset classes, but extends to the management of those asset classes, (2) you not only have dynamic asset allocation, you also have dynamic risk allocation - your risk profile isn’t a snapshot of a risk tolerance questionnaire you took three years ago, it includes a risk required, risk desired, and your risk composure which changes when your situation or the markets change. This space defines your full risk spectrum range. Relative Trend can slide in that range based on current market behavior and capitalize on your full risk profile, (3) you already have a plan for when to sell and what to buy in its place, no need to wonder if now is the time to buy back in or when to sell (4) you remain invested in the asset class in case the market continues on a constructive path; while this dynamic risk management technique provides an intriguing risk-adjusted return, it is vulnerable to whipsaw markets that generate false positives. Relative Trend Portfolios should be viewed as a short-term insurance policy that may not be needed, but serve as an emotional backstop to possible bad behavior, and (5) knowing this approach, how it works, and understanding its triggers, makes you more likely to stick to your financial plan.

Much like a balance bike allows kids to focus on what attributes of learning to ride at a time (balance), our rules-based, Relative Trend Portfolio approach converts three moving targets into one and allows us to focus on our life goals. The Relative Trend Portfolio serves as a control for market and personal bad behavior within our personal risk profile, so we only have to do one thing at a time.

What is a Relative Trend Portfolio?

According to Corey Hoffstein…

Performance tends to persist in the short-run. The theory behind trend equity is that behavioral biases exhibited by investors leads to the emergence of trends. Trend equity strategies seek to capture this potential inefficiency.

Using Relative Trend Portfolios with smart beta indexes create unique opportunities. Smart beta indexes are concentrated subsets or reallocated equity within an index with a specific strategy.

Relative Trend attempts to identify behavioral inflection points that are (a) indicative enough to say a trend has shifted, (b) provide an opportunity through this switch to outperform either index on its own, and (c) prevent oversteering leading to excessive trading or excessive opportunity cost on the upside where an “all in” or “all out” is more vulnerable to false positives.

Relative Trend Portfolios attempt to further diversify your portfolio while capturing market inefficiencies created by market behavior. The intent behind this approach is to enhance client adherence to sticking to their financial plan and improving investing success by isolating all the moving targets.

Most people have unreasonable expectations when it comes to investing - mainly outcome based (big returns) and time (fast). Investing should be about a successful process than enable the life you want to live - what you want to do and when you want to do it with your money. We focus on process with an emphasis on reducing risk, reducing expenses, reducing taxes while hoping to improve returns in a market we have no control over so that you can live the life you want. We believe our Relative Trend tactics are a critical ingredient to increasing the probability to achieving your goals.

Current Relative Trend Portfolio Holdings

Asset Class Offense Defense Current Change Date Index

US Large Cap MTUM USMV Defense 10/1/2018 SPY/ITOT

US Small Cap EES SMMV Defense 9/14/2018 IJR/ITOT

Global VT ACWV Defense 8/20/2018 VT

International IMTM EFAV Offense 6/13/2019 SCHF

Emerging Mkts FNDE EEMV Offense 4/15/2019 SCHE

EM Bonds VWOB SCHZ Offense 2/6/2019 SCHZ

Hi Yield Bonds ANGL SCHZ Offense 4/30/2019 SCHZ

Bank Loans SRLN SCHZ Defense 1/15/2019SCHZ

Strategic Inc RIGS SCHZ Defense 2/5/2019 SCHZ

Competing vs. Comparing

Competing comes from Latin meaning “strive with”.  That sounds quite appealing, but rather contrarian to what many Americans do.  Even more so in the investing world.

Competing against yourself, tends to always be healthy.  You are comparing yourself today, to yourself yesterday.  Are you improving? We should all strive for that.

My lens for comparing took a sharp turn for the worse in April.  I was asked to come up with a metric driven algorithm to grade and “force rank” 700 Agile App Development Teams (I have accidentally become a software consultant, but it keeps my business acumen and intellectual curiosity peaked).

I had several reservations to this that also apply to the investing world:

1.     Short-Term Measurements can lead to dangerous behaviors.

2.     You create winners and losers when we are all on the same team.

3.     What is the benchmark and is it relevant

And for the sake of what?  More effort to rank teams based on a multi-variate analysis of complex systems won’t get you anywhere - it won’t in investing either.  The more effort you spend, the more marginal decay you will have. You have to keep it simple and just make it about temporal comparisons.

Investing leads to a “competitive” mindset.  Many think that if you spend more time on this that you should have better outcomes.  When you listen to all the talking heads on CNBC or Bloomberg, they are all trying to crack the code, but what is funny is that nobody really talks about how good someone else’s ideas are.

What I find is that I can pick any timeframe and make myself look good and the client can pick any timeframe and make me look bad.  

This from Ben Carlson this week in Fortune

Since the peak of the dot-com bubble in 2000, the S&P 500 has delivered annual returns of just 5.3%. Yet since March 2009, returns are more than 16% per year. Go back to November 2007 and returns are a more pedestrian 7.3% annually. Yet going back to 1995, returns are close to 10% per year, dead on the long-term averages.  

There will always be ammunition for both sides of the bull and bear debate in almost every security or market imaginable for the simple fact that markets are cyclical. That means you can win any argument about the markets by simply changing your start or end dates to suite your stance.

Here is where the concept of comparing breaks down.

I am yet to see a single investment plan that is built on beating the market.  I am yet to see a client who has a picture of themselves with their money. The comparison is meaningless.  What matters is that the client understands their life goals are the only thing that matters and that I am helping them achieve that with the highest degree of confidence that is building over time. They are striving with themselves.

What if I had the best investment returns for every advisor in the state of Virginia?  So what? Beating other advisors isn’t what I am here to do. I am here to enable client wealth.  That may mean taking less risk and having lower returns that another advisor, another fund, or God forbid, your blowhard neighbor or brother-in-law.  Walks, singles, doubles will be at the plate a lot longer than strike outs and home runs. Funds in the top 20% one year aren’t likely to be there next year – so be warned.

Comparing has nothing to do with who is richer, who is happier, who is more intelligent.  It has to do with ego.

Compare kids to other kids is a personal emotional trigger.  Think of how flawed this is. My son – he is 11, and 67 pounds. He has friends that outweigh him by 50 pounds on his baseball team.  He has struggled at the plate this year. He went from batting .380 to .240. However, there is a lot of missing context in those numbers.

More importantly, my son is a pitcher and he hasn’t seen many opportunities on the mound this year (his heart is breaking, and mind right along with him.  He loves to pitch. His room is like walking into Clayton Kershaw’s locker at Dodger Stadium. His statistics, when I compare them to others, are pretty good. However, when I compare them to his teammates, I get resentful that he hasn’t had more opportunities.

Easy the biggest pain point for me is that his first time he ever pitched, he pitched 54 pitches.  He hasn’t reached more than 45 this year.

When I compare them to his previous years pitching, my resentment turns to pride.  His first year pitching, he had 50.5% strikes. Now he is up to 64.8% strikes. I have seen him work (and continue to work without the opportunities) and I couldn’t be happier for his ability to not get discouraged.

Let’s talk about my daughter.  She is on a soccer team of nine.  I am lucky I know how to even spell soccer. She enjoys the game and her teammates. More importantly, her teammates enjoy each other and have no ego at all.  Shannon is probably a tier II player. She is motivated, she is smart, but she isn’t the most talented. She will do fine because it is easier to educate the motivated than motivate the educated.

She hasn’t scored this year.  However, she leads her team in assists AND she has read over 100 books year to date.  Most comparisons are isolated to one metric. I want her to score for her own fulfillment.  That said, when I look at her full body of work, she is quite an accomplished little girl.

In both cases, if you compared my kids to others on their team, I grow irritated.  Am I not working enough with them? Are they lazy? Are they really not interested?  What can we do differently?

When I take the time to compare my kids today to their yesterday, that frustration turns to contentment. Higher strike percentage, fewer walks, better change-up, more assists, better conditioning. They are doing the best with the hand they have been dealt.  End of story.

Now look at your investment profile and your life goals.  If you are working to do the little things – save before you spend, understand your risk profile, follow the retirement plan, and stop looking at the stocks scrolling by CNBC, you are in a much better place because you are working to be better than you were yesterday.

Just like with my kids – if you choose to compare, you will likely introduce fear, greed, envy, and regret – all unhealthy emotions, that may cause you to do something more dangerous and more regretful.

Josh Brown has some wonderful parting advice.

If you’re not a professional investor, don’t waste time and energy comparing yourself to the pros or to any other benchmark that is irrelevant to your future spending needs. At best, it will make you anxious and envious during the inevitable periods in which you’ll find yourself behind. At worst it will cause you to do things that are unnecessary and dangerous.

There is no reason to waste your time and energy and emotional capital comparing yourself to a benchmark that (a) doesn’t care about you, and (b) is irrelevant to your future spending needs.