Trend Following: Weed Control for Portfolios

A powerful motivator for many parents is a desire to have their children’s upbringing to be better than their own. Better schools, a nicer house, more toys, and better vacations are all things many of us wish for our kids to experience – especially if we didn’t have these things in our own childhood. I know this is certainly the case for me as a father of two.

And yet, there are many aspects of my childhood that I have become nostalgic about as I grow older. Certain things that I either didn’t enjoy or outright despised, I now remember fondly. In fact, I lament the fact that my kids will never be able to experience some of these things themselves.

An example will help explain. And, perhaps unexpectedly, I think it offers a valuable lesson about investing.

Weed Early, Weed Often

I grew up on a small, family farm in central North Carolina where we grew crops such as tobacco, corn, and hay. For livestock, we raised cattle and had a pretty significant poultry operation as well, collecting eggs from more than 20,000 hens at a time. As has always been the case, farming is tough and margins are thin, especially for a relatively small outfit like ours.

It was common, in our community anyway, to have a family garden. Anything that could be grown, harvested, and preserved would reduce the number of items to be purchased – which was hugely important on a tight budget. Green beans, potatoes, cucumbers, tomatoes. This time of year, planting season, reminds me of that part of my story.

There were many chores I loathed growing up on a farm, but none more than weeding the garden. Between the heat and the tedious nature of it, I would typically volunteer for arguably harder chores to avoid pulling weeds. The truth is, my mother knew I hated it, so she usually just did it herself. But there were times when I had to, and I hated every minute of it.

Now I assume almost everyone understands this principle, but maintaining a crop by eliminating weeds is vital. Weeds grow quickly and compete with the crop for vital nutrition. Another important characteristic of weeds is that they are much more easily pulled up when they are small. Once they spread, the roots strengthen and they can become entangled in the crop, making removal even more time consuming and annoying. Early and often weed control, while unpleasant in the short term, is essential for a good yield.

If you’re a frequent reader of our blogs you are probably waiting for me to weave this into an investing lesson.

Well…

Wait for it…

Wait…

OK, here it comes…

Trend Following is a Natural Weed Killer

In our opinion, the hateful weed and its removal provides a valuable tutorial for responsible portfolio management. Like weeds, the impact of losing positions are much more easily managed when they are young and small. Weed control, like loss control, is more effective when it is done in an unemotional, disciplined manner – early and often.

As losses grow, particularly when an investor allows themselves to be emotionally attached, their roots grow stronger. They can become further entangled in the portfolio, making their elimination more difficult and also more damaging.

In our opinion, one of the most powerful benefits of systematic trend following, which we practice, is the detached removal or reduction of losing positions. Losses (i.e., weeds) are pulled each month in favor of pouring those resources towards more favorable positions (i.e., crops). The goal is to keep compounding as high as possible so that when the season ends (e.g., retirement), there is plenty stored that can be drawn on when needed.

The Full Circle

Believe it or not, now that I have a family of my own, we do in fact have a garden of our own. But pulling weeds in a few 10-by-4-foot raised beds is not the same as weeding an acre or more. So, as spring heats up and seeds have and are going into the ground, I look back fondly on my childhood, even the chores like pulling weeds.

I have mixed emotions about what it means for my kids. I’m grateful they don’t have the same struggles, but I learned so much from those challenges.

Regardless, I plan to give them the “you guys have it so easy” lecture repeatedly, like many fathers do, and amusedly watch them roll their eyes in return. I also am grateful that I can apply these principles to my daily routine of portfolio management for financial advisors and their clients. Pulling weeds is no fun but having them affect the harvest – or having losses affect a client’s financial future – is much worse.