Coming From Behind - Investment Lessons From Sports

FORECASTS & TRENDS E-LETTER
By Gary D. Halbert
June 2, 2009

IN THIS ISSUE:

1. Update on My “Coaching Career”

2. Investors Playing Catch-Up

3. Remember The Object Of The Game

4. Don’t Forfeit The Game

5. Have A Good Offense And Defense

6. Player Selection

Introduction

Back in 2006, I wrote an E-Letter that applied sports analogies to the investment world in an attempt to create a better picture for how you should manage your investments. Because of the extent to which I have been involved as a coach in my son’s and daughter’s sporting activities over many years, I found that E-Letter to be both very interesting to write, and it was popular with my readers.

This week, I want to revisit the sports analogy because the investment world has changed substantially since 2006. After reaching a peak in October of 2007, stocks were hit by a bear market that continues even as this is written. Between October of 2007 and March of 2009, the S&P 500 Index lost over 50% of its value. Even worse, 2008 saw most bonds suffer losses right along with stocks, something that Investing 101 tells us shouldn’t happen.

As a result, many investors have had their portfolios decimated. Putting it in terms of our sports analogy, they are losing the game and have no idea how they might stage a comeback. With that in mind, let’s revisit some of the analogies I discussed in my previous E-Letter, as well as some new ideas that might apply to your more recent investing experience.

A Personal Coaching Update

Before launching into a comparison of sports and investing, I thought I’d update you on my personal coaching activities that served as the springboard to the original sports analogy E-Letter article. My long-time clients and readers will recall that 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.

It all started when I took my son to his first tee-ball practice many years ago, and 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. Soon, I was given a cap and tee shirt and was designated as the assistant coach. Little did I know that I would go on to coach not only baseball but also football and basketball for years thereafter.

I was not a jock in college, so 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. Thus, whenever I say that you should “do your homework” in relation to investments, this is the kind of thing I’m talking about.

I continued to coach my son’s baseball team in high school at the private Christian school he attended and where my daughter still attends. I even helped out with the football team for several years, which went on to win a State Championship. However, when my son graduated high school last year, I thought that would be the end of my coaching career. To my surprise, the school asked me to help coach the baseball team again this year, and I happily agreed. See photo of “Coach Halbert” with some of the baseball players and coaches at the end-of-season party late last month. Needless to say, coaching sports has been a real joy in my life.

All of this background is to say that I am more than just a casual observer in regard to the nuts and bolts of coaching, and have found that my coaching activities are sometimes similar to my role as an Investment Advisor. 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 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 practices and on the playing field: coach them to be more successful. This has never been more important than now, when many investors are finding themselves at the brink of defeat at the hands of the worst bear market since the Great Depression.

Investors Now Playing Catch-Up

One of the most frustrating parts of coaching is getting way behind in a game. It not only takes scoring a lot of points just to catch up, but can also lead to emotional reactions by players who give up and simply want the game to end. It goes without saying that many investors now have a lot of lost ground to make up, and I am concerned that many of them seem to be giving up on meeting their investment goals.

As the recent bear market has led to significant losses, some investors have started to focus on their own emotional reactions and have taken their eyes off of the ultimate goal. Emotions can be the enemy of sound investing just as they can lead to defeat on the field. I’m sure all of us have witnessed overconfident teams that build a big lead only to eventually lose the game, or teams that get so far behind that they hang their heads and just wish for the game to be over.

In sports, attitude is a big part of a successful program, and it can be a big part of recovering from an economic setback in the investment game. No, having a positive attitude won’t miraculously lead to market gains, but it can lead to taking proactive steps to continue toward your investment goals. Some defeated investors sit and mope about past losses and feel unable to take action, while the winners take steps to learn from their experience and seek out options.

Just as it’s not easy to come from behind in a ball game, there’s no quick way to make up investment losses. There are things you can do to help get back on track, but there are other actions you can take that may actually hamper your progress toward your investment goals. In the remainder of this E-Letter, I’m going to suggest ways for you to “get back into the game.”

Don’t Forget the Object of the Game

Whether in sports or while investing, it’s vitally important that you remember the object of the game. Perhaps the funniest, yet most frustrating years of coaching 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 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 playing 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, and they opt 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 their focus is misguided. 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.

The same can be true today, as many investors are trying to find investments that can help them “make it all back” quickly. In doing so, they sometimes take on more risk than they would otherwise be comfortable with. While aggressive strategies may be the key to higher future returns, they could also result in losing even more of an already smaller nest egg. I’ll discuss more about how to use aggressive strategies later on, but they should never make up your entire portfolio, no matter how good their past performance may be.

Focus on the Fundamentals

I have heard many professional coaches with teams in a losing slump talk about how they are directing their team to focus on the fundamentals. While I realize that the term “fundamentals” already has a meaning in the investment industry, for purposes of this discussion the term “fundamentals” will refer to the basic skills that are required to play any given sport – or construct a diversified portfolio.

In baseball, fundamentals include pitching, fielding and hitting, among others. Football, soccer and all other sports have their own set of fundamental skills. Professional coaches know that it is improbable that any team will be successful unless all players have a grasp of the basic skills necessary to play the game. Sometimes, however, there are pressures and distractions that take players’ minds off of the basics.

So, how does this relate to investments? First of all, it means that outside influences can sometimes divert an investor’s attention from the basics of good investing. Accordingly, getting back to the fundamentals means to focus on how you got the money to invest in the first place. For most of us, that means working hard and saving money. Until recently, saving money was out of style in the US. As recently as 2005, the savings rate was actually in negative territory. Apparently, many Americans mistakenly decided they could spend their way into a comfortable retirement.

Fortunately, the savings rate is now rising, so the first fundamental that I would encourage you to work on is increasing your savings. Or, said another way, decrease your discretionary spending and live below your means. This also means reducing your debt load along the way. It doesn’t do much good to save money while piling up credit card debt. The net effect is still low (or no) savings, since the creditors will always have to be paid off.

Others among us have amassed wealth by building a business. While it’s not always possible to rebuild a business from scratch, or start a new business after one has been sold, some entrepreneurs are doing just that now that their nest eggs have been eroded by the bear market. It is rarely an easy path, but it is one that can prevent outliving your money in retirement.

The next fundamental skill of investing is to diversify. Here, unfortunately, many investors have had the misfortune of having some poor coaching in years past. That’s because they were led to believe that “Modern Portfolio Theory” (MPT), asset allocation and various other buy-and-hold investment strategies somehow provided sufficient diversification.

Over the course of my coaching career, I have had the opportunity to coach with several very successful former professional athletes. I can tell you, it didn’t take long for us non-professional, volunteer coaches to figure out that we had a lot to learn. To this day, I still see volunteer Dads teaching kids things that are either wrong or outdated.

Much the same is true, in my opinion, when it comes to most stockbrokers and financial planners who broadcast Wall Street’s buy-and-hold mantra across the country. Accompanied by flashy proposals and sophisticated sounding reports like “correlation matrices” and “Monte Carlo simulations,” these promoters sold an entire generation of investors on the idea that allocating assets among a group of stock and bond asset classes would protect them in a market downturn.

What they didn’t count on was that many of these historical relationships often break down in a bear market, just when they’re needed the most!

As we now know, this poor attempt at diversification didn’t work in the 2000 – 2002 bear market nor has it worked in the one we’re in right now. Yet, many of these buy-and-hold adherents continue to counsel their clients to “keep running that play until you run it right.” In other words, stay invested and hope that you don’t need your money until the market recovers.

Fortunately, many investors have now realized that true diversification means having a variety of investment strategies in a portfolio, not just a collection of securities that happen to fit in different sections of the Morningstar style box. Specifically, active management strategies that can move to cash or hedge in down markets are catching on like wildfire because they have historically offered true diversification, many with low correlation to the equity markets.

Monitor Performance Regularly &
Make Changes When Necessary

Professional sports franchises spend a huge amount of time, effort and money to monitor and evaluate the performance of their superstar athletes. They know that a weakness, if left unchecked, can mean the difference between winning or losing a game – or even a championship! Likewise, investors should make it a priority to monitor the progress of their investments, but I have found that this important step is often overlooked.

Over the years I have been surprised at how many investors don’t monitor the performance of their various investments regularly. It is very important to continually monitor your investment performance to insure that you are on track to meet your investment goals. Monitoring has always been an important part of the investment process, but today it is even more critical. Unfortunately, many investors learned this lesson too late to help prevent past losses, especially in the case of the current bear market.

Too many just assume that their broker, advisor or planner will make or recommend changes if they are needed. Unfortunately, this is often not true. Ask yourself, what broker or advisor is going to tell you that you should close your account and move the money elsewhere? Answer: probably none.

Also, many brokers are restricted to selling only those products offered by their firm. In such cases, the broker is not likely to tell you about other investment opportunities that may be performing better, or that may offer much-needed diversification in your portfolio. As noted above, the last thing they want is for you to move your money elsewhere.

Whenever possible, you want your broker, advisor or planner to be independent, with the ability to analyze and recommend a variety of investments or funds from different sources. Typically, such independent advisors are “fee-based” rather than “commission-based.” Put differently, you want someone who is on your side of the table, and will not hesitate to recommend a change, if needed.

Here’s where my firm can help. We are truly independent. We not only recommend third-party money managers, but we also monitor the performance and trading of each manager on a daily basis. Since I have my own money with every single money manager and program that we recommend, it is easy for us to track their real performance daily.

We compare the performance of my accounts to the published “official” track record and evaluate trading patterns to see that they comply with our expectations for each strategy. We are also in frequent contact with each manager we recommend to make sure that they have not made material changes to their strategy or system.

And finally, because we are independent, we do not hesitate to recommend that you “fire” a manager if the performance does not live up to reasonable expectations, or if they do make material changes to the strategy or system that are untested.

Add a Little “Razzle-Dazzle”

Almost every football team I have ever observed has at least one “razzle dazzle” play. Also called “trick plays,” the term refers to plays that are out of the ordinary and totally unexpected by the defense. Examples have names like the Statue of Liberty play, guard-around play, halfback pass play and my favorite, the flea-flicker.

Plays like this are designed to catch the defense off-guard and, hopefully, lead to a score. In my experience, I have seen such plays shift the momentum in a game and lead to a victory for the underdog. However, just as often, I have seen these plays blow up and lead to a score for the opposing team. In other words, they are risky.

Earlier on, I mentioned that I would discuss how to use aggressive investment strategies to help diversify an investment portfolio. Shifting our focus to the investment world, a good analogy to the razzle-dazzle play would be aggressive investment strategies that employ sophisticated trading techniques. I originally wrote about this concept in my April 14 E-Letter, and I feel that such strategies can bring needed diversification to a portfolio in the right circumstances.

Just as a razzle-dazzle play in football contains something unexpected by the opposing team, aggressive investments often employ sophisticated trading strategies that used to be confined mostly to the secretive hedge fund industry where only the wealthy had access. Today, however, advances in mutual fund design make it possible for money managers and investors alike to access funds that employ leverage, that can “short” various stock indexes and even provide access to markets such as commodity futures and currencies.

These investment strategies are often based on a quantitative trading model developed by a professional Investment Advisor. Using a variety of indicators such as trend analysis, momentum, technical analysis and a host of others, these trading models seek to anticipate and capitalize on shorter-term market moves. To be honest, most of these aggressive programs provide lackluster results, and can have severe losing periods, but there are some such as Scotia Partners and Third Day Advisors who have produced favorable returns over a number of years. Of course, there’s no guarantee that they will continue to do so.

When these programs are on a winning streak, they often win big. However, just like the razzle-dazzle play in football, they are risky and can also lead to significant losses. Thus, just as no sports team could get away with running trick plays all of the time, allocations to aggressive investment strategies should be limited, no matter how good their past performance may be.

Have 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 enough on the other, you’re not likely to win many games. There’s an old football saying: “Offense wins games, but defense wins championships.”

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. 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.

If you have read my E-Letters for long, you know that my main emphasis is on avoiding large losses in your investments. Likewise, you’ve probably 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%

This breakeven table is why I like to emphasize active management strategies that can play both offense and defense. 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.

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 baseball, you see teams that can hit the ball well, but lack a good defense in the field – 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 field the ball well and make good throws.

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.

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 they 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 in the broadcast and print media and the Internet that causes this. Or maybe it’s a matter of thinking that we should have picked up investment knowledge somewhere during our education.

Unfortunately, this sense of self-direction has led many to adopt “canned” buy-and-hold approaches from the Internet or any of the hoards of “how-to” investment books. Don’t get me wrong, some do-it-yourself investors have done quite well, often by applying some form of active management to their portfolios. However, many of the do-it-yourself investors who have contacted us have not fared well over the past decade.

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, an independent professional Investment Advisor can help investors by:

Scouting out and evaluating various investment managers representing a number of different approaches to the market;
Using detailed investor questionnaires and discussions to develop a playbook designed to work toward his or her individual investment goals;
Assembling a team of independent, professional money managers whose strategies have the potential to work together over time to help moderate the risks of being in the market; and
Monitoring the performance 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. 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. Yet, when used to create a diversified portfolio, they can work together in such a way as to provide meaningful risk-adjusted returns and limit losing periods.

Conclusions

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 focus on their jobs or businesses, doing what they like to do and allowing professionals to handle most or all of their investments.

To that end, it would be a pleasure for Halbert Wealth Management to serve as your investment coach. We have been evaluating professional money managers for over 30 years, and we 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.

Wishing you profits,

Gary D. Halbert

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