What do Baseball and Investing Have in Common?
What do baseball and investing have in common?
Baseball players with the highest number of home runs usually also have the highest number of strikeouts.
. . . so how does this relate to my investments?
Common wisdom isn’t always wise
The “common wisdom” is to be extremely aggressive when you are young by making your exposure 80% to 100% equities, but this advice ignores your risk tolerance and temptation to sell at or near the bottom that most inexperienced investors face after their portfolios fall -30%, -40%, or even -50% or more.
Then to make matters worse, they wait too long to get back into the market after most of the gains have occurred.
As we discussed in a previous Newsletter, the average equity investor saw returns of 3.79% per year over the past 30 years while the S&P 500 returned 11.06% per year*.
This is why we put so much emphasis on investing within your risk tolerance and taking the long view.
*Source: Dalbar’s 2015 Quantitative Analysis published by The Motley Fool, “The Average American’s Investment Returns – and How You Can Do Better”, Matthew Frankel, CFP, November 1, 2015, updated October 2, 2018.
Why it doesn’t pay to take maximum risk
. . . so let’s look at some examples of how Risk (Maximum Loss) relates to Return, or why it doesn’t pay to take maximum risk
The table and graph below are examples of the Returns and the Risk associated with benchmark allocations ranging from conservative to extremely aggressive.
You can easily see how the Return (Compound Annual Growth Rate – CAGR) increases very slowly as more Risk is taken while the Maximum Loss starts out large and increases very quickly as more Risk is taken. In addition, the less risky portfolios never beat the S&P 500.
The following charts and tables cover the 15-year period preceding March 13, 2020.
Standard allocations using the broad bond index AGG with the S&P 500 (SPY)
What happens if we use U.S. Government Treasuries instead of AGG?
You can see in the chart and table below that when we use U.S. Government Treasuries for the Safety allocation instead of the broad bond index ETF AGG, the Returns and Maximum Losses are improved.
Also notice how taking less risk in the Moderate, Moderately Aggressive, and Aggressive allocations returned 89%, 111%, and 108% of the S&P 500 return with much less downside risk – you don’t need to swing for the fences to get good returns and in fact you’ll get better returns in the Moderately Aggressive allocation by taking less Risk! Base hits win the game.
Combining U.S. Government Treasuries (Safety) with the S&P 500 – SPY (Risk) improves up and down performance.
What does this all mean for you?
Don’t let anyone tell you how much risk you should take based on your age – especially when you’re younger. Don’t give into the pressure and the misinformation that you must take maximum risk to get maximum returns.
Fill in the table below and understand how much loss you can easily live with. Take that amount of risk in your portfolio allocations, and don’t sell when the markets are bad. You’ll be much better off now, and many years into the future.
. . . and stop swinging for the fences.
Table to help you understand your tolerance for loss
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This information is provided by Clear Capital Management LP (“Clear Capital” or the Firm”), a Registered Investment Advisor Firm with a principal office in the Commonwealth of Pennsylvania, for informational purposes only. No portion of the commentary included herein is to be construed as a solicitation to affect a transaction in securities or the provision of personalized investment or tax advice. The Firm’s market discussion and investment models are based on the Firm’s proprietary research and back-tested market data. This back-tested data has been prepared with the benefit of hindsight, and the market trends and economic conditions on which these statistics are based may not endure in the future. Past performance is no guarantee of future results, as there can be no assurance that any particular strategy or investment will prove profitable in the future. Composite account performance reflects the reinvestment of dividends and other related distributions, as well as the deduction of the Firm’s wealth management fee. Any reference to a market index or benchmark such as the S&P 500 or the Aggregate Bond Index is included for comparative purposes only, as an index is not a security in which investment can be made. Indices are unmanaged benchmarks that serve as broad market or sector indicators and do not account for management fees or transaction costs generally associated with investable products. Clear Capital may discuss and display, charts, graphs, formulas and specific stocks which are not intended to be used by themselves to determine which securities to buy or sell, or when to buy or sell them. This information offers limited information and should not be used on its own to make investment decisions. Investing involves risk, including the potential loss of principal, and investors should be guided accordingly.