Sports, Good Coaching & Investment Analogies

FORECASTS & TRENDS E-LETTER
By Gary D. Halbert
December 19, 2006

IN THIS ISSUE:

1. Know The Object Of The Game

2. Don’t Forfeit The Game

3. Having A Good Offense And Defense

4. Player Selection

5. Conclusions & Merry Christmas

Introduction

This week, I want to borrow some of the excitement related to the professional football playoffs and college bowl season to draw some analogies between sports and investing. Though sports analogies are sometimes overdone, my extensive involvement in my kids’ teams gives me a great perspective that I think you will find informative and entertaining.

Sports are a huge part of life for the Halbert family. My 16 year-old son plays football, basketball, baseball and is an active wakeboarder/wakesurfer in the summertime. My 14 year-old daughter has played basketball and softball for years and is also a serious wakeboarder (we live on a lake). So we’re a sporting family year-round.

Due to no plans of my own, I got involved in coaching youth sports over a decade ago, and it has been one of the greatest blessings I have ever had in my life. When I took my son to his first tee-ball practice many years ago, I noticed that there was only one coach and about 15 kids, some of whom didn’t even have their gloves on the correct hand. So I stuck around to help until the other coaches arrived. No one else ever showed up.

At the second practice, the same thing happened, so I helped again – never once imagining that I was embarking on a coaching career. At the end of the second practice, the coach motioned me over to his pickup truck, reached inside and handed me a team tee shirt and said, “You’ll be my assistant coach.” It didn’t sound like there was a choice in the matter. As it turned out, this fellow was the president of the local youth sports association, and he and I went on to coach not only baseball but also football and basketball for the next several years.

I was not a jock in college, so I had no intimate knowledge of baseball, football or basketball, other than my high school experience and as a viewer of sports on TV. Thus, I was hardly a candidate to become a good or successful coach. As a result, I have stacks of videotapes on coaching youth sports in my closet, which I used to educate myself on how to coach the various sports.

I continue to coach my son’s baseball team at the private Christian school he and my daughter attend. FYI, my son’s Varsity football team won the State Championship two weeks ago! (See photo.) We are already gearing up for the 2007 baseball season which kicks off in January. They keep asking me back to coach, and I keep saying YES (thank you very much). I love it! Coaching sports with these kids is a real joy in my life.

Now this is a long and personal introduction to make the following point. Over the years, I have noticed that my coaching activities are sometimes similar to my role as an investment manager. In other words, the role I play in my clients’ financial planning is that of an investment coach. For the last 30 years, I have been helping clients with their investments, educating them on the do’s and don’ts and steering them toward professionally managed investment products.

In essence, I’m trying to do the same thing with investors that I try to do in sports practice and on the playing field: coach them to be more successful. While it seems that sports analogies are becoming almost trite, my experience has been that there are some key premises in relation to sports that I believe apply very well to the field of investments. With that in mind, let’s look at some of these analogies and see how they might apply to your investing experience.

The Object Of The Game

By coaching my son and daughter through various ages, I have been able to see how they and their teammates have developed over the years. Perhaps the funniest, yet most frustrating years were the early ones, where many of the kids did not realize what the game was all about. If you have ever attended a beginners’ tee-ball game, you probably know what I mean. Whenever the ball is hit, it seems that every player on the field takes off after it. They completely forget about strategy, thinking that the real object of the game is to get the ball, not play their positions.

As odd as this may sound, there are many adults who are doing exactly the same thing in relation to their investments. They do not take the time to sit down and determine their long-range goals, so they settle for chasing after the latest “hot” stocks or funds or investment fads, without a long-term game plan or a disciplined strategy.

Other investors think that they have a better understanding of the game, but focus on the wrong things. Like the baseball player who ignores his coach’s signals and “swings for the bleachers” every time he’s up to bat, some investors concentrate on hitting investment home runs and take on way too much risk. A classic example was the “dot-com” boom in the 1990s, and we all know how that turned out.

In either case, the end result can be that investors lose the game. Fortunately, the object of the investment game is usually quite simple – to meet long-term financial goals. Whether it is achieving the lifestyle you reasonably desire, funding your kids’ college education, saving for a comfortable retirement, or whatever, you must be a good saver and have a plan and a strategy for your investments. A good investment strategy is one that balances returns versus risks.

Don’t Forfeit The Game

One of the most frustrating feelings in the world is to lose a game by forfeit. It means that, for one reason or another, you couldn’t put a team on the field and had to give up without even trying. It’s a lousy way to lose a sports competition, and even worse when applied to investments.

Once the object of the investment game is known, there are still a lot of questions. The investment industry is truly one of the most confusing places to try to navigate, sometimes even for experienced investors. Thus, some investors become so confused by all of the various offers, claims and strategies that they do nothing. In essence, they forfeit the game.

If you doubt this statement, just consider a recent study of nine million 401(k) participants by Fidelity Investments. The study found that many participants have all of their money in just one investment. Of those, nearly 40% have all their assets in conservative investments such as so-called “stable-value” funds, which are little more than glorified money-market funds, or fixed-income funds.

Others show up for the game and play the first half, but then give up. I have often written about investors who bail out of the market when losses become too high, only to invest in the next “hot” stock or mutual fund, and end up getting burned again. Eventually, some of these investors get to the point where they can’t bear the thought of losing any more money and move all of their funds to CDs, T-bills or similar investments that provide relative safety, but with returns that barely keep up with inflation.

Just as there are people who should never play sports because they have no interest or talent, I’ll be the first to admit that there are people who should not invest in the equity markets in any way. The reason is that their risk tolerance is such that the thought of losing any money would keep them up at night. This doesn’t mean that they will never meet their financial goals, but it does mean that they’ll likely have to save a lot more to do so.

It is my opinion, however, that most investors need the potential growth that equities can provide to meet their financial goals. However, giving up on investing (or never trying in the first place) will not likely lead to their success. What these investors need are strategies that seek to balance risk and reward, with the potential to minimize losses while also participating in up market gains.

Having A Good Offense And Defense

Another important analogy between sports and investments is the idea that you can’t concentrate on just offense or defense, you have to play both. If you focus too much on one and not the other, you’re not likely to win many games.

There’s an old football saying: “Offense wins games, but defense wins championships.” That was never more true than in our football State Championship game two weeks ago. My son’s team (he plays safety on defense and receiver on offense) held the highest scoring team in the division, and their runningback who rushed for almost 3,000 yards and 37 touchdowns on the season, to ZERO POINTS in the second half and won the State Championship 16-13.

Over my years of coaching, I have witnessed sports teams that have a fantastic offense, but their defense could not keep the other team out of the end zone. On the other hand, I have also seen teams with strong defenses that couldn’t seem to put a score on the board. It just makes logical sense that being strong in one or the other does not necessarily mean you’ll win the game.

While this is a common sports analogy, it may surprise you that a number of popular investment strategies used by millions of investors are all offense and no defense. As I will discuss below, I think most “buy-and-hold” investment strategies Wall Street offers could be described this way. Only if the market goes up do you make money, and when it goes down, you can lose big.

This is why I like to emphasize both offense and defense on the playing field, and why I favor “active management” strategies for most of my investments. Most active management strategies include the flexibility to exit the market (partially or fully) or “hedge” long positions if market trends turn ugly. This is one good way of playing defense in your investments. However, they also have ways to put the offensive unit back on the field through sophisticated strategies for getting back into the market.

Why Defense Is So Important, But Often Overlooked

If you have read my E-Letters for long, you know that my main emphasis is on avoiding large losses in your investments. I apologize if you’ve already seen the table below (we publish it often), but it can’t be repeated too often in my opinion. The breakeven table below illustrates just how devastating large losses are, and how difficult it is to recover from them.

Amount of Loss Incurred	Return Required To Break Even

10%	11.1%
15%	17.7%
20%	25.0%
25%	33.3%
30%	42.9%
35%	53.9%
40%	66.7%
45%	81.8%
50%	100.0%
60%	150.0%
70%	233.3%

When you take a loss, you have less capital to work with. The larger the loss, the harder it is to recover. If you take a loss of 30%, for example, you have to make almost 43% to just get back to where you started. Tables and statistics are nice, but let’s get to a real example that happened to millions of investors.

In the bear market of 2000-2002, the S&P 500 Index plunged by over 44%. Many investors rode it all the way down because they took Wall Street’s advice in the late 1990s to buy and hold low-cost “index” funds, many of which mimicked the S&P 500. To recover from that 44% loss, investors had to make over 80% just to get back to breakeven. Now four years later, the S&P 500 has still not recovered to its peak in 2000.

It is also important that you go beyond the traditional measures of risk, which are usually presented by the mutual fund world as calendar-year losing periods and standard deviation. While both of these pieces of information are good to know, what the above graph shows you is the amount of the “drawdown” (peak to valley loss), and what it takes in earnings to get back to break-even.

Since I covered the concept of drawdowns extensively in my December 5 E-Letter, I’ll not go into detail here. However, continuing our sports analogy may help you to better understand this concept. Drawdown is like allowing the other team to run up the score on you, and then trying to make up the difference. It seems to make the most sense in both sports and investing to limit the extent to which you get behind, and this comes from playing defense.

Those who promote buy-and-hold “index investing” counter this argument by saying the markets have always overcome drawdowns in the past, so they expect them to do so in the future. However, what if the clock runs out on you? I’m sure we’ve all seen sports events where one team is fighting its way back, but runs out of time on the clock before it can score the winning points.

An analogous situation applies to investments, in that even if the indexes do eventually erase their drawdowns, what happens if retirement, death, disability or college educations need to be funded before the markets get back to break-even. Even worse, what happens if you need the money while the investment is still in the midst of a major drawdown? This is the reason why proponents of index investing often focus primarily on the long-term historical market performance, without much emphasis on the losing periods, and without much regard for what your individual time frames may be.

The overall goal of “active management” strategies is to moderate the downside risk of being in the market, a critical ingredient in any “absolute return” investment program. When risk management is applied in relation to your individual time frame, it can be a winning combination. In my view, this is the way to play defense in your investment portfolio.

Player Selection

Now that we have established that both offense and defense are necessary ingredients on your investment team, it’s time to turn our attention to player selection. In football, you see teams that can run the ball well, but lack an adequate passing game – and vice-versa. But it is generally agreed that to win championships, you need a balance of both. On the defensive side, you must be able to defend against the run as well as the pass.

In many ways, investing is no different. You are usually best served by a diversified portfolio with multiple investment strategies. However, this is easy to say, and sometimes hard to do. After all, how and where should you invest? What investment strategies should you include or exclude from your portfolio? How do you evaluate the various players to select the best team?

The investment industry is truly one of the most confusing places to try to navigate, sometimes even for experienced investors. There is an overload of investment and market information out there, and much of it is conflicting or outright wrong. We are constantly bombarded with investment information from the mainstream media, cable networks and the Internet, not to mention our mailboxes.

A discussion about which of the many investment strategies should be part of a diversified portfolio is far beyond the scope of my remaining space in this E-Letter, though I have written about the pros and cons of various strategies in previous issues. For purposes of our sports analogy, however, the important thing to remember is that, just as player selection is an integral part of a successful sports team, strategy selection can be critical to a successful investment portfolio.

Think of it this way – in the 1990s, many investors loaded up on Internet and tech stocks and related funds, to the exclusion of most others. They thought the “new economy” would carry them to riches beyond their wildest dreams, yet we all know that didn’t happen. Unfortunately, loading your portfolio with investment strategies that are similar (or exactly the same) would be like putting all linemen on the field, or all pitchers on the diamond.

Just as an effective sports team must have players with various skill sets, so should a diversified portfolio consist of different investment strategies.

So, how should you go about selecting the most appropriate players for your investment team? Where should you send your scouts? What analysis should you run on each? What performance statistics are the most meaningful, and what “intangibles” exist that might mean the difference between success and failure?

I think most people realize that they do not have the ability to evaluate an athlete’s strengths and weaknesses to determine if they should be on a sports team. Yet, these same individuals often feel that they should be qualified to select investments for their portfolio. Why should this be? After all, very few people try to be their own banker, lawyer or doctor, but seem to have no problem trying to be their own investment manager.

From my 30+ years in the investment business, I think the primary reason many people take on their own investments is that there is an expectation that they should be able to do it, even though there is no good reason why. Perhaps it’s the flood of investment information on the broadcast and print media that causes this. Or maybe it’s a matter of thinking that we should have picked up investment knowledge somewhere in our education.

So, going back to our sports analogy, what do team owners or schools do when they need someone to evaluate players and put the best team on the field? That’s right, they hire a coach!

Good Coaching Makes All The Difference

And now we’re back to where I began, with the realization that much of my sports coaching experience relates, to a certain extent, to the investment management services my company offers. As an investment coach, my firm can help investors by:

Scouting out and evaluating various investment managers representing a number of different approaches to the market;
Using detailed investor questionnaires to develop a playbook designed to work toward his or her individual investment goals;
Assemble a team of independent, professional Investment Advisors whose strategies have the potential to work together over time to help moderate the risks of being in the market; and
Monitoring the play of each Advisor as the game progresses to know when it may be best to send in a substitution.

In sports, it is often true that the best-coached team wins the game, rather than the one with the most talent or ability. In my son’s recent State Championship victory, I can certainly say this was the case. The other team was definitely larger, faster overall and very talented. Yet, at the end of the game, they came up short on the scoreboard. Our kids played with a lot of heart, but I also know that their coaches had a big hand in preparing them for the game, and utilizing their various talents in the most effective way as the game played out.

The same can be true in the investment world. Many of the funds and investment programs we recommend never hit the “Top 10 Investments” list that I wrote about in my December 5 E-Letter. Yet, when used to create a diversified portfolio, they can work together in such a way as to provide meaningful risk-adjusted returns.

Conclusions & Merry Christmas

Imagine the following scenario: You are attending a football game and the home team is struggling against a worthy opponent. Suddenly, a fan jumps out of the stands, walks onto the sidelines, fires the coach and takes over the team. Not long after, the self-appointed new coach becomes disappointed in his players, so he suits up himself and goes onto the field to play in the game.

Sounds ridiculous, doesn’t it? Yet, this kind of thing happens every day in the investment game. Investors often take over the reigns of their investments for one reason or another. Sometimes, they do well, but in many instances, they do not. In my opinion, investors are usually best served when they spend time doing what they like to do, and allowing professionals to handle their investments.

To that end, it would be a pleasure for me to serve as your investment coach. I have been evaluating professional money managers for over 30 years, and I have a team of quality managers just waiting to get on the field for you. And I have an excellent staff of Assistant Coaches (Investment Consultants) that are standing by to help you evaluate your goals and get started. Together, we can handle all or part of your investment portfolio.

If you’d like to learn more about the investment management services we offer, just give us a call at 800-348-3601 or e-mail us at info@halbertwealth.com. Or, you can request that we call you by clicking on our online contact request form.

Since this is my last E-Letter before Christmas, I want to take this opportunity to wish each and every one of you the Merriest of Christmases. My prayer is that you have a warm and wonderful holiday with your family and friends, and that any travels you may embark upon are safe.

I’ll be back on December 26th with my regular weekly E-letter. Until then…

Wishing You the Happiest of Holidays,

Gary D. Halbert

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