Beware Barnyard Rules Investing

January 11, 2010

Originally published 1/10/2010 at the FPA's All Things Financial Planning Blog

Robert Schmansky, CFP(r)

 

In early grade school, my next door neighbor and best friend Mike and I were absolutely inseparable. Any free time you could find us engaged in all varieties of physical games — from basketball, football, to roller hockey. You name the sport, and we could be seen trying to make a one-on-one game of it in our parents’ yards.

 

Often, Mike’s older brother would challenge us to a game, any game, of two-against-one. Inevitably, when the tide turned against him, anyone within a hundred yard radius could hear a shout of “Barnyard Rules!” This was our warning that the accepted rules of the game were off. The law of the jungle prevailed.

 

Having grown up in the suburbs of Detroit without a farm within miles, to this day I can’t fathom where he came up with the term, Barnyard Rules. To me, it has always meant using whatever advantage you have to get the job done in the short-term, ignoring the principles (the rules) of the game, and the consequences (generally physical injuries) of breaking them.

 

Barnyard Rules has come to mean even more to me as I’ve read Dr. Stephen Covey’s books on principles. He frequently uses the example of life on the farm to describe what principled living means. Farmers do not simply declare ‘Barnyard Rules’, and harvest a higher yield of crop. Principles might best be described as things that are, simply because they are.

 

Likewise, a principled investing plan requires accepting the fundamental truths of markets, your role as an investor, and the knowledge that speculative investments that would tempt us out of greed, or fear, to ‘win’ the game, are simply the ‘barnyard rules’ seeking to gain hold.

 

Reacting to the downturn, many investors have shed principles. They believe they are adjusting to ‘new realities.’ But in truth, they are ignoring — consciously or not — time-tested sound investment principles. Those include seeking higher returns and yet ignoring the risk, giving into fear or greed and pursuing speculative investments, and not maintaining investments whose purpose is to provide safety and stability, despite their yield. It is true that we have endured a far worse than expected investing “season.” And yes, systematic economic and financial threats, just like hurricanes or droughts, could always bring hard times to the farm again.

 

But, ask yourself: Is your objective in the new strategy investing for sustainable crop yields, year in and year out? Or are you trying to scratch out a little more yield this year, to next year’s detriment? Or are you running for cover because the sky looks threatening?

 

Interestingly, I see many investors beginning to ask the same questions that burned them before the downturn — where can I get the most yield; what investment will generate the highest return; should I buy a risky stock; who has the advantage — and how can I get a part of it?

 

Thanks to Morningstar’s monitoring of investor returns, we can see the consequences of this line of thinking.

 

For example, one of the best performing domestic mutual funds over the last 10 years, CGM Focus Fund (CGMFX), has a 10 year average annual return (through 11/30/09) of 18.79 percent — handily beating the S&P 500. However, due to the nature of many investors that such performance attracts — i.e. those impatient investors looking for spectacular returns — the average investor in the fund fared dramatically worse. Specifically, the average CGM Focus Fund investor lost an average of 11 percent over the same time period.

 

On the farm there are no shortcuts for long-term success. Shortcuts — failing to invest in proper equipment maintenance — only create long-term problems. The Barnyard Rules always end in pain and loss. Farms would not produce if their farmers dumped principles. Investors that continuously leave investing principles for the latest pitch or product likewise should be concerned about their prospects for achieving their long-term goals.

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