Modern investing owes a lot to behavioral finance research, the scientific study of how we make choices, particularly about money.
Nevertheless, and with apologies to baseball great Casey Stengel, investing can be pretty well understood by thinking about just five of the longtime manager’s classic quotes, from the Baseball Almanac:
1) “Been in this game one-hundred years, but I see new ways to lose ’em I never knew existed before.”
Money managers counsel against owning a stock you doesn’t understand. Then they proceed to recommend dozens of shares that almost nobody understands, including themselves. Small investors try to reduce complexity by owning only a few stocks of well-known brands, usually based in their own country. Worse, they hold cash and shares in their own employers’ firms and nothing else. Meanwhile, increased complexity has led the big pension funds to hire outside guns to keep track of it all.
Bottom line: You can know your own business inside out and still lose your shirt overnight. Owning someone else’s business is orders of magnitude more complicated. Diversify with indexes and your risk subsides.
2) “Can’t anybody here play this game?”
Mark Hulbert, the newsletter tracker, recently wrote about how the newsletters were “beating up” on hedge funds this year, returning 9% through November vs. just 5.5% for the fancy funds. Surely he must realize that the S&P 500 returned 12.61% in the same period, right? Meanwhile, The Wall Street Journal’s David Weidner points out that a lot of stock pickers followed in the media took a bath in 2012. You can blame volatility, if you like, but volatility is not exactly news. In fact, up-and-down markets are supposed to favor the gurus. So why are the pundits’ picks no better than flipping a coin?
Bottom line: You can lose a lot of money following gurus. Once you blow through your capital, there’s no easy way back.
3) “I don’t like them fellas who drive in two runs and let in three.”
If you’ve ever seen a mutual fund prospectus, you’ve seen the performance table. It spells out how well the fund has done over several time frames, usually year-to-date, one year, three years and five years. Then big database companies will average comparable funds, giving you a look at “typical” performance. Only it’s not typical. The averages suffer from a statistical quirk known as “survivorship bias.” By eliminating the funds that go bust, the remaining funds contribute to a rising average return.
Bottom line: Remember that averaged returns are goosed up to look good by conveniently forgetting dead funds that have closed down. A passive fund, however, will be accurate since it reflects the benchmark, not a selection of winners.
4) “Managing is getting paid for home runs someone else hits.”
Parents understand this moment intimately: After raising, feeding, clothing and educating a child, at some point he or she gets up, leaves your home and begins to make adult decisions well beyond your view and without the slightest thought of your guidance or approval. Awful, right? And yet, if you did your part, totally harmless. Yes, your kids will make some bad choices. That’s what life lessons are about. Investing is no different. You’re much better off saving more and paying attention to asset classes than trying to micromanage the past.
Bottom line: The less you pay attention to the details of the market’s moves, the more likely you are to collect the gains that occur over time.
5) “Most ball games are lost, not won.”
Markets go up and markets go down. You can’t affect it in any way, and least of all by watching. The trick, as Charley Ellis points out, is to make fewer mistakes.
Bottom line: Passive investing and rebalancing is as close to a free lunch as you will find in your investing life.