It’s Super Bowl season, and I’m once again reminded of the unlikely parallels between football and investing. This connection dawned on me 12 years ago, when a storied NFL quarterback asked me to discuss his wealth advisory needs.
The quarterback was known as a cool-headed competitor on the field, able to consistently make correct decisions under pressure. So I was surprised to learn that he had built – and was committed to maintaining – a portfolio with an 80% allocation to high quality municipal bonds. This overly conservative stance was the result of emotion, which he had tamed so well on the field, but seemed powerless against as an investor.
Simply put, the 2001-2003 dot-com meltdown had rattled Mr. QB like no pass rusher ever had. In response to it, he had decided to play it safe for the rest of his life on the investing front. The problem: Doing so would likely prevent him from reaching his long-term financial goals.
Mr. QB would have done much better by applying his football IQ to investing. Football is a game that requires both risk and caution. When a quarterback passes the ball, he accepts the risk of an interception in exchange for the potential reward of a big-yardage gain. On the other hand, he can greatly reduce the risk of a turnover by handing the ball off to a running back. But there’s a drawback: Though running plays are more conservative, they usually yield smaller yardage gains than passing plays.
Like football, investing requires making decisions about risk and potential reward. If you invest in a stock, you generally accept more risk than investing in a bond. But stocks are like passes: They can yield far better returns than bonds. Good investors maintain a balance of stocks and bonds attempting to make significant gains while also tempering risk.
In both football and investing, there is a time when it makes sense to take on more risk, and a time when it makes sense to be more cautious. Let’s say a football team has the ball 80 yards from the goal line, with the game tied and limited time left on the clock. Running plays will mitigate the risk of losing the ball – and the game – but they likely won’t get the team to the goal line before time expires. So passing plays are required.
But what if a team has the ball five yards from the opponent’s goal line in the same situation? In this case, passing not only carries more risk than running, but it’s probably not necessary. There’s a high probability that a good running back will be able to score within a few attempts.
Investors, like football teams, must have the presence of mind to use the right amount of risk in the right situations. That brings us back to my meeting with the quarterback. His objective was to maintain his comfortable lifestyle throughout retirement, and leave some principal to his heirs. The problem: his spending needs contrasted against his cautious allocation and long time horizon made his goal impossible. Effectively he was 3rd and long on his 20-yard line and wanted to run the ball.
Given the low returns from such a cautious portfolio, his portfolio was likely to only generate enough income for a comfortable retirement if he lived below his current lifestyle and if inflation sunk to 0% and stayed there for the rest of his life. Realistically, neither was going to happen. Simply put, Mr. QB was set up to fumble away the most important play of his financial life.
Investors frequently make poor, emotion-driven decisions when they are under pressure, and the fear of another market crash “turning over” his savings had tripped up Mr. QB. By the way, he is far from alone: A 2010 Allianz study concluded that more than three quarters of respondents fear running out of money more than they fear death.
To make matters worse, it appears that investors change their tolerance for risk based on their environment. In a research paper published in the Journal of Financial Planning, Michael Finke and Michael Guillemette sampled the risk tolerance measurements of close to 350,000 individuals before and after the 2008 financial crisis. They found a clear pattern of investors changing their risk tolerance as market conditions changed. “At its face, it seems fairly obvious that investors would be less risk tolerant when the stock market is underperforming,” Guillemette said. “However, this may lead to investors buying when the stock market is high and selling when the market is low.”
Translation: Mr. QB has plenty of company among investors who let their emotions warp their decision-making, and potentially put their long-term goals out of reach.
Want to win your Super Bowl? Then take a page from the football playbook — pursue your goals by making rational decisions about risk and reward. And when the pressure is on, just as it is with today’s volatile markets, stick with the game plan.