If you're more excited about the beginning of the football season than sitting down to make a financial plan, you're not alone. Football is a spectacle, but planning your investments is work.
But maybe they have more in common than you think.
Although saving and investing for the future may seem like a very complex endeavor, the major concepts can be explained in relatively simple terms. In fact, you can learn a lot from football strategy that can then be applied directly to managing your money.
Preseason: Planning for Success
You cannot achieve any of your long-term investment goals without a well thought out financial plan. Like football teams that spend a significant amount of time in the preseason determining their overall team strategy, determining their offensive and defensive formations and what players are ready for the season, investors must also determine their overall investment objectives, what strategies they will employ and which assets they should purchase before constructing a portfolio.
Just like a football team, an investment portfolio needs a solid offense and defense. The offensive and defensive strategies are determined through the assets that are purchased.
On a football team, players are picked to play a specific position on the field and it is the quality and application of their talent that has the greatest influence on a team's ability to win games. In investment management, each asset has a specific role in achieving an investor's long term financial objectives. In fact, it's the asset allocation between investments in securities like equities, bonds, and alternative assets that have proven to have the greatest impact on a portfolio's investment performance.
For example, in many portfolios a large allocation to equities is an offensive strategy that can be compared to the passing game, as equities can be the engines that can drive substantial performance quickly. However, like the passing game, which is susceptible to interception and increases the risk of injury to key players like quarterbacks and wide receivers, equities are also riskier in relation to most other assets and can cause investment losses and portfolio values to swing unpredictably.
Investing in bonds can be compared to the ground game. Using running backs does not usually result in large yardage gains, however it does provide stability in the offense and reduces the risk of turnover. Like the ground game, bonds provide portfolio stability and although performance is often less than that of equities, it is much more consistent and in investment terms does not provide as much risk.
However, bonds (like the running game) can lead to poor or negative performance. When interest rates rise or when bond issuers experience credit problems bond prices can suffer significantly.
Think of alternative assets, such as real estate, commodities, private equity, and hedge funds, as special teams, which tend to make up a relatively small part of the overall game plan. Alternative assets are tactics used for return enhancement or as a defensive measure to add additional risk mitigation.
The risk borne by the portfolio by investing in these assets will depend on the allocation and the inherent risk of the asset, where many real assets have risk profiles somewhere between bonds and equities and some actively managed hedge funds may be riskier than stocks. It's kind of like going for two instead of the extra point, the conversion has a smaller probability of success but a greater performance potential for the risk involved.
The allocation or portfolio composition percentage of these assets in the portfolio not only provide the offensive power but also the defensive muscle. Like football defenses trained to identify offensive formations and to defend against various offensive situations, investment portfolios mitigate risk through diversification that uses several asset exposures to defend against various market scenarios.
Having multiple players on a team with specialized roles that perform differently in different game situations, risk management entails purchasing multiple securities or asset exposures that perform differently in different market situations.
Like defensive linemen that are the first line of defense against the running game and the secondary that is guarding against the long ball, having a lot of lot of different securities that perform independently of each other in reaction to the same market scenario means that when one asset is performing poorly another is hopefully performing well. This results in a greater probability that the portfolio will continue to provide an adequate return over time regardless of outside economic and market forces.
The right coach
Another valuable and necessary part of any team is the coaching staff. Investors who are not confident about their investment management skills or simply need additional assistance from an investment professional should solicit the help of investment advisers. Like the head coach and general manager, who are involved in all aspects of the team including game strategy and personnel selection, investment advisers can help investors set goals, define strategy, design a portfolio, and help purchase the assets.
In addition to providing knowledge and guidance, their purpose is to keep everything working consistently, to determine when strategy or resources need to be changed or modified, and eventually to optimize performance.
The most important thing to remember is that a football team needs to follow a well thought-out overall strategy, and your investment portfolio is no different. It is not enough to have forty-six talented players dressed and ready to play - they need to know what to do! Many investors make the mistake of concentrating too much on the assets in their portfolio - should they buy this stock or that one - and forget that the way they operate together is dramatically more important.
If you take one lesson from this comparison, it should be the importance of a thoughtful and well constructed plan. If it sounds daunting to put that together, don't worry, there are many financial advisers (the equivalent of coaches) to help you play to win.