Just like on ball field, financial planning involves optimizing for past results and probabilities.
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As you cheer your team in this year’s World Series, consider that America’s favorite pastime can teach you a lot about America’s main preoccupation: money.
How does baseball resemble your investing or financial decisions?
1. Probability of outcomes matters, whether concerning stolen bases or investment returns and financial goals.
2. Separating a manager’s skill and luck takes a long time.
3. A quality process matters more than immediate or short-term outcomes.
4. Dazzling past performance clouds present decisions and doesn’t guarantee future outcomes.
5. Specialists work best where they add the most value.
6. Scouts are to fans as investment managers are to average investors, making informed decisions using advanced data and resources. No informed decision is foolproof.
7. Best to worry only about what you can control.
8. Good teams and investment plans use a documented approach to evaluating present conditions and building for the future.
9. Most mutual fund managers are the equivalent of common baseball cards.
Baseball is our most statistically driven sport; we can digest piles of data about each game. Investing offers a similar ton of data to evaluate company stocks, bonds, economic conditions and investor psychology, to name just a few conditions. Beyond past returns and the price/earnings ratio of a stock, investment evaluation goes much deeper with formulas, algorithms, and even a measure called “batting average” that evaluates how an investment manager’s results compare with an unmanaged benchmark.
When I was a kid I loved Strat-O-Matic Baseball, an old-fashioned game in which you roll dice to manage a team and consult player cards for the outcome based on probabilities from past performance. Luck did figure heavily in any single roll of the dice; play long enough, though, and probabilities won out. Much as on Wall Street.
Baseball also evolved into a game of specialists filling specific roles. Pitchers, catchers and shortstops use distinct skills. Investment management is similar: A balanced approach that considers the broad universe of return-seeking opportunities and risk management requires a diverse mix of specialists.
The mix of luck and skill can be hard to evaluate in investment managers. Sometimes you misinterpret a single lucky event to the point of inflating the performance of the manager for years to come.
The probability of any investment manager consistently identifying winners and timing entry and exit with such holdings is low. Just as past performance doesn’t stop baseball general managers from offering obscenely lucrative long-term contracts to players whose careers are fading, investors steer a lot of capital toward money managers based on past market performance and returns.
How does the probability of scoring change if a baseball team has no outs and a runner on first base, compared with one out and a runner on second? Who’s at bat and what’s that batter’s past performance against the pitcher?
Will company earnings continue to grow and justify higher stock prices? How far and fast will interest rates ever climb? Will eurozone stagnation drag down the global economy, and, if so, how far?
To cite one financial firm as an example, my partners and I rely on probabilities of outcomes when creating long-term financial planning and asset projections. We use Money Guide Pro software – the Strat-O-Matic of financial planning – to model how assets, future income streams and expected investment returns might satisfy your retirement income, college savings, travel, health care and other long-term goals. We’re comfortable with a 70% to 80% probability. Insisting on much higher probability means building a plan for only the worst possible financial scenarios and can cause shortfall in your funding.
The investment world always carries an element of uncertainty, the relationship between risk and reward. Even if we accurately gauge the probability of investment outcomes, we won’t make successful money decisions every time. Fluid factors can disrupt probabilities.
An untimely double play quickly ends a promising rally. Retire a year early or spend more than you planned right before your golden years and your probability of funding retirement income changes. Lose your job and automatic payday funding to your investments temporarily dries up.
The challenge in financial planning and on the ball field: We optimize for past results and probabilities and still retain little control over outcomes, especially when we move beyond numbers and into your situations and goals changing through your game of life.
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