Balancing Long-Term Goals versus Short-Term Risks

Abstract

In investing, there can sometimes be a tension between long-term goals and short-term risks. The investor might have a specific end goal in mind when structuring an investment portfolio, but the realization of a short-term risk in the interim can force a stop out before the end goal is achieved. One can think of margin calls, solvency triggers, or even behavioral effects. These are situations where it is not only the end goal that matters, but also the journey toward it. In this article, the author derives the probability of the investor reaching a target hurdle value at the end of the investment horizon without breaching a lower barrier value during the investment horizon. The addition of an intrahorizon loss constraint can lead to meaningfully different investment behavior. The article describes three stylized examples to demonstrate the practical consequences and provides some tools on how to manage the trade-off.