As we kick off a new football season, it’s an ideal time to talk about what football can teach us about investing, particularly about risk.
Teams (like investors) are too often prisoners of convention and make poor decisions because they follow tradition instead of making the statistically “smart” decision. The best teams take controlled risks to win a football game. The best investors need to take controlled risk to create a successful portfolio—one that will allow them to win in retirement.
To illustrate my point, let’s look at what happened in this year’s Super Bowl just before halftime: the famous Philly Special play. Philadelphia was on the two-yard line in a fourth-and-two situation, up by three points (15-12) with 34 seconds before the whistle. Prevailing wisdom for the Eagles would be to kick a field goal. Statistically from that distance, that move will succeed more than 95% of the time. This means the decision is worth at least 2.85 points.
By choosing to go for a touchdown instead, Philadelphia Eagles Coach Doug Peterson turned conventional wisdom on its head. But it worked because he understood the odds and took a controlled risk. The probability of scoring a touchdown from the two-yard line is 60%. This means the decision is worth 4.2 points, or almost 50% more than a field goal. In a shootout against the greatest quarterback ever (Tom Brady), this was the smart move.
As we all know, the decision worked, and the Eagles wound up 10 points ahead at the half in a game that they ultimately won by eight points. Instead of running away from risk, Doug Peterson embraced it and made a good decision on a risk/reward basis.
Getting back to investing, what do we mean by risk? The old investing paradigm says risk comes from uncertainty and the best strategy is to play it safe. In our football analogy, that would be kicking a field goal and taking the easy three points. But the real risk isn’t one play going bad; it’s losing the game.
Think about the time an investor has to accumulate assets as equivalent to the 60 minutes of game time. By looking at the whole game rather than just one play, we can see that there are times when it will be advantageous to take on calculated risks to achieve the desired outcome.
For example, conventional wisdom for the investor with a long horizon is constructing a 60/40 portfolio of equities and bonds. However, that model was constructed when 10-year U.S. Treasurys yielded 6%-8%. In today’s world, where the 10-year U.S. Treasury yield TMUBMUSD10Y, +0.01% is 3%, but the S&P 500 index SPX, -0.82% is expected to yield 8%+, the traditional portfolio does not make sense. After taxes, inflation, Fed rate hikes, and manager fees, the fixed-income allocation could literally be destroying wealth.
Instead, in this environment, the long-term investor should tilt the portfolio more heavily to equities. It’s a “smart” risk. Moreover, although often overlooked, achieving growth during boom periods can actually serve to de-risk portfolios because it gives the investor some breathing room during the tough times.
In football, conventional wisdom says a conservative running game that avoids risk is the best strategy, as summed up by the legendary college coach Woody Hayes: “When you throw a pass three things can happen to it, and two of them are bad.” But successful coaches today know you need to throw to win. You need big plays. You need to take risks to win a football game. The same is true for investing.
And all that really matters is the score at the end of the game.
Also read: This NFL exec’s technique for assessing football players also works on stocks
James Hickey is a chartered financial analyst and chief investment strategist for HD Vest Financial Services.
