Goals-Based Portfolio Theory

CHAPTER 5Real Markets, Real Risk, Real Portfolios

“Foresight is not about predicting the future, it's about minimizing surprise.”

—Karl Schroeder

For the latter‐half of my childhood, I grew up on a working cattle ranch in central Texas. As you can imagine, there is always something to be done on a working ranch—haul hay, feed cattle, work cattle, fix fence, and so on—and this kind of work in the heat of the Texas sun imparts an appreciation for the tools of the trade. No two tools loom larger on working land than the tractor and the horse.

Tractors are quite handy, of course. You can haul hay, fix fence, and plow fields with tractors. The best thing about a tractor, however, is its reliability. So long as it is well‐oiled and full of diesel, you can turn on that tractor and go to work. It does exactly what you tell it to do.

Horses have their own advantages. They are great at reaching those rugged nooks and crannies of land, and almost nothing is better for herding other animals than a good horse. Horses, however, are bigger and stronger than we are, and, unlike tractors, they have a mind of their own. If you wake up to a horse who does not want to work, there really is nothing you can do about it. And, occasionally, a horse gets spooked and decides to buck you off.

In modern finance, replete with our deterministic equations and empirical studies, we have come to view markets as though they were tractors. In our minds, markets have become a tool that we can reliably use to ...