What do the World Champion 2007 Red Sox have to do with investing?
It probably is not a surprise that as the managing principal of a business called Fenway Financial Advisors I am a Red Sox fan. Like many throughout New England, I look forward to another Opening Day where we can celebrate last year’s World Series Championship. With spring training right around the corner, investors can learn a lot from the success of the Red Sox and this issue’s article offers a few of those valuable lessons.
It takes a whole team with lots of different skills
The most important thing in baseball and investing is to have lots of different “players” each with different skills in your lineup. There are the stalwarts like large company stocks (think Jason Varitek) and the volatile home-run hitters that can come up huge in the clutch like small company stocks (Manny Ramirez perhaps). You can have old reliable bonds (veteran Curt Schilling maybe) or future Hall of Famers from the ranks of mid-size company stocks (flamethrower Josh Beckett comes to mind). No team is complete without the international talent of a Daisuke Matsuzaka or a David Ortiz or the emerging market talent that comes from nowhere like Hideki Okajima. And you shouldn’t be afraid to take a few small chances on the non-conforming investment that may pay off big when you need it most (who could predict Clay Bucholz’ throwing a no-hitter to stop a 4-game losing streak?).
It’s a numbers game
Statisticians love baseball. They also love investments. Actually, the two are much the same. Baseball and investing both boil down to numerical measures of human behavior. Here’s another parallel. While the casual fan tracks the hits and home runs, the professional baseball manager focuses on subtle but important numbers with funny acronyms like ERA, WHIP, PPAB and OPS. Likewise in investing, casual investors often focus on returns, whereas the professional financial advisor is often more interested in risk related statistics with Greek names like alpha, beta and sigma. While there are never any guarantees, measures of risk and its supporting cast of Greek statistics are often a greater predictor than past returns of how a portfolio is likely to behave in the future. It pays to know how your portfolio risk stacks up statistically.
Give your investments a chance
If your name wasn’t Terry Francona or Theo Epstein, you probably wanted to toss Dustin Pedroia in the Charles River every time he hit a weak ground ball to second base during the first month of last season. He went on to become the 2007 American League Rookie of the Year. If you’ve been following the stock market lately, you’re probably ready to dump a lot of your own investments into the Charles River. Every athlete has slumps, as does every investment. While there may be times when your players and certain kinds of investments need a breather, both athletic performance and financial performance tend to be cyclical. Reversion to the mean is never guaranteed, but it is an extremely powerful force in baseball and investing.
The 2007 Red Sox were incredibly consistent. While they never won more than 5 games in a row, they also never lost more than 4 games in a row during the regular season, but they still had the best record in baseball and went on to win the World Series. In most investment categories simple index funds (funds that just buy and hold a basket of investments) usually beat actively managed funds (where a manager tries to time the market and pick successful investments). While outsized gains may generate the headlines, it’s the quiet consistency and low cost of index funds that typically wins over the long term.
The coach isn’t there to play the game. He simply establishes a game plan, sets the starting line-up and makes a few small but important changes during the game based on the current situation. An investment advisor should do the same, helping you to establish a plan and develop a strategy targeted at implementing that plan, recommending an initial line-up of investments and making a few adjustments along the way. One of the hallmarks of both a good coach and a good financial advisor is not to tinker too much with the players.
Give your employees the right motivations
Imagine paying your general manager based on how many players you traded – you would never have the same team on the field two days in a row! Can you imagine an owner telling the general manager, “I’ll give you a percentage of the value of the team’s payroll every year.” Instead of putting the best team on the field, the owner probably would just end up with the most expensive. You should never pay a broker or advisor on commission or based on a percentage of your assets. To get the most out of your advisor, avoid these inherent conflicts of interest and pay your advisor a reasonable, mutually agreed upon flat fee. If he or she does a good job, reward them with referrals to new clients.
If you would like to put us in your dugout, please call 617-948-2102 and we’ll be happy to set up a complimentary initial consultation. Go Sox!