Tuesday, May 31, 2011

Why Investing is like Sports

Is your interest in the fortunes of your favorite sports team any different than your interest in the fortunes of the stock market?

Let’s say you are a fan of American football. Your team plays a game every Sunday for 16 weeks (except for one off day). How do you feel when they lose? How do you feel when they win? How do you feel when they win or lose a few games in a row? Here’s a graphic that will help us illustrate our point:

Do you have any detachment when it comes to how you feel about Your Team’s success or failure? Of course not. One Sunday you want the quarterback to run for President and the next you want him to run from the stick you are wielding. Is any of this logical? Of course not. You feel it in your gut. Your brain is there to merely prevent you from running your car off the road when the coach elects to go for 2 - when the PAT kick would tie the game - and doesn’t get it and your team loses. Now you know the feeling we’re talking about – some days you feel like the elevator can’t take you high enough and some days you only want to take it so you can jump off the building – preferably with the afore-mentioned quarterback or coach firmly in your grasp, along for the ride.

Guess what?

This is exactly how many investors approach investing. If the Dow is on a 3-day winning streak, they are euphoric, they can’t see an end to the up-ticks on the chart and wonder why they didn’t invest more last week when the Dow had a 3-day losing streak. They berate themselves and their advisors for missing out. And why didn’t we get into (fill in the blank with the over-priced IPO of your choice) when it opened? Yet, during the 3-day losing streak, they were despondent and nearly suicidal over not having held back more cash.

Call it the human condition. Here are 6 ideas investors can use to avoid the elevator ride between hope and despair:

1. Build a portfolio based on your intellectual tolerance for risk. Keep it simple – use mutual funds. Re-balance it periodically. In between re-balancing, ignore it.
2. Don’t buy market-capitalization weighted index funds – their ups and downs are multiplied by the overweighting in large companies. Consider equal-weighted index funds.
3. Buy dividend-paying stocks in large US companies that make things that people buy or that sell the things the other companies make. According to Modern Portfolio Theory, it only take 8 stocks to diversify business and industry risk. Divide your capital by 8 or more and go shopping.
4. Reinvest all dividends for individual stocks that allow you to do so. This compounds your dividend yield.
5. Don’t watch the markets everyday – or even any day. Invest your funds and then ignore them for whatever time frame you’ve determined will pass before you will conduct a review. Monthly? Quarterly? Semi-annually? Annually?
6. Hire an advisor who understands you to do this for you.


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