"The Art of Winning an Unfair Game"

Today's Brief explores our natural affinity toward speed and power in our investing options. Why is it that we almost universally tend to swing for homeruns when singles and doubles will get the job done? 

In his book Moneyball: The Art of Winning an Unfair Game  Michael Lewis told the story of Oakland Athletics’ baseball manager Billy Bean’s success in taking one of the poorest teams in major league baseball to the top against teams with two and three times their salary budget. Billy came to believe that on-base percentage and slugging percentage were better indicators of offensive success than industry-standard qualities such as speed and contact with the ball. In other words, simply getting on base more often, no matter how you do it, is more important than stealing bases, batting runs in, or batting average.

But the concept of ‘slugging' it out being superior to ‘speed’ is certainly not new with Billy Bean or Major League Baseball. Back in 560 BC or so a fellow named Aesop depicted the theory in his fable The Tortoise and the Hare. You know the story; the arrogant hare, after ridiculing the slugging tortoise, takes his challenge to a race. After quickly leaving the tortoise in the dust, the over-confident hare tires and decides to take a nap only to find later that he has been passed by the steadily plodding tortoise.

But who would bet on a tortoise in a race against a hare, except maybe Aesop or the tortoise? It just doesn’t make any sense. We seem to be naturally drawn to the speed of the hare, the daring of base stealers, and the power of the big home-run hitters. In the same way, in our investing, we are attracted to the hottest mutual funds and stocks. They are so much more appealing than plodding, boring  index funds.

So let's have a little race ourselves. If you could go back to 2000 and pick just one stock, knowing what you know right now (without further study), which one would it be? I’m guessing Apple would be top-of-mind for many. Since the beginning of 2000 Apple has generated a cumulative return of 2,232% or 29.3% annually. A sum of $100,000 invested in Apple on the last day of 1999 would be worth $2.3 million today.

Now let’s make this race really interesting. What if you were 65, ready to retire, and that you could choose to retire here and now, with no knowledge of the future, or you could go back to January of 2000, with perfect knowledge of how two investment choices would perform? You have $1 million and want to spend  at least $80,000 of it annually. Your choice consists of keeping your dull index portfolio consisting of 60% stocks and 40% bonds and cash or Apple. As with Apple’s return of 29.3% you learn that your portfolio will return 4.9% annually for the next 12 years. Which one will you choose?

If you succumbed to temptation and picked the Apple, I’ve got some bad news for you: in mid-July of 2007 you would receive a phone call from your advisor informing you that your account was fully depleted. You just got kicked out of paradise.

Alternatively, if you opted for the ‘tortoise' portfolio, of 60% stock and 40% bonds, you would have plodded comfortably along, through 2007, 2008, 2009, 2010, 2011, and 2012. As of March 31^st of this year, you would still have $197,308.

Data Source: Morningstar

As you look at the data above, the first thing that might surprise you is just how badly Apple got hit in 2000. Just a moment ago, when you were making your selection, you likely remembered 2000 was a tough time for tech stocks, but that stellar12-year return you heard about, likely helped persuade you to set 2000 aside as an ugly and horrible outlier. But as you look at the numbers more closely, see what a cost to lifestyle that ‘ugly outlier’ inflicted. Your portfolio fell from $1,000,000 in 2000 to $266,430 in just a year.

Back to our metaphor; what a costly nap that was for our hare! But maybe all would not be lost though. The following year’s 64% sprint might just get him back in the race, but alas, another rest stop for 31.2% would be required. From there, the race was over. Our hare ugh, Apple would never catch up, even with blistering hops of 45%, 183%, 157%, and 25% in the years that followed.

The birds-eye view shows that the race was never really close.

If you are the New York Yankees with $125 million to throw away every year, then you can afford some flashy rabbits. But if you more closely identify with the Oakland A’s on one third that budget, perhaps some steady slugging is the wiser course.

The wisdom of Aesop’s Tortoise and Hare  has been around for some 2,500 years to guide the investment practices of those who heeded. But wise investment counsel actually dates considerably further back. Speaking for God back in 920 BC, King Soloman wrote “The plans of the diligent lead to profit as surely as haste leads to poverty.” Proverbs 21:5.

Have a great weekend.