What Golf Can Teach Us About Investing
August 30, 2016 | Your Finances
In my profession, one of my primary objectives is helping individual investors reach their long-term financial goals. One of the ways I do this is by studying the biases that affect investors’ decision-making processes. The awareness of these biases not only helps me to be a better investor but also allows me to provide our clients with relatable guidance.
As a sports fan, I subscribe to the theory that the world of professional sports is a microcosm of life. And I’ve found that what’s true for athletes is often so for investors—both tend to make decisions based on behavioral biases. Perhaps no sport provides as fertile a laboratory as golf, in which competitors must continually weigh risk and reward to navigate an ever-changing hole-by-hole environment in the context of a 72-hole tournament. Golf, like investing, is an emotional experience in which pressure can lead to suboptimal decision making.
Over the past few decades, a field of economics known as Behavioral Finance has taken root. Essentially, “behaviorists” believe that biases and human emotion play a critical role in the decision-making process and can lead to irrational and often poor decision making. A foundation for this field was laid in 1979 when Nobel Prize-winning professor Daniel Kahneman and his colleague at Princeton University, Amos Tversky, developed Prospect Theory. Without delving too deeply into the geeky details, Prospect Theory asserts that humans make decisions based upon the value of individual gains and losses rather than the more rational analysis of maximizing the overall final outcome. The reason is that they internalize losses more than they value gains (loss aversion).
Recent research has shown that professional golfers are also subject to Prospect Theory and loss aversion. In a 2011 study, professors at the University of Pennsylvania1 analyzed putting data from the PGA Tour during the years 2004-2009. Controlling for a number of variables, the authors found that 94 percent of golfers made par putts about 2 to 4 percent more often than they did birdie putts of a similar distance and difficulty. Birdie putts were left short of the hole, while par puts finished past the hole. The professors found that golfers were willing to sacrifice success in putting for a birdie (gains) to avoid encoding the loss of missing a par (loss). In other words, golfers view making birdie as less important than missing par, although rationally they should be indifferent and seek only to maximize their total score; after all, a stroke is a stroke. The golfers that the authors interviewed quipped that gaining a stroke was not as important as not losing one.
Investing Lessons From the 2016 PGA Tour
1. Maintain a diversified long-term focused portfolio. In 2016 we saw four first-time winners of the PGA Tour’s major golf tournaments. Interestingly, a mere 14 players made the 36-hole cut in all four majors. Indeed, PGA Championship winner Jimmy Walker missed both the U.S. and British Open cut before claiming victory in the last major of the year. Contrast that with U.S. Open winner Dustin Johnson, who followed up his win by finishing 18 strokes off the pace at the British Open and not making the PGA Championship cut. In other words, using each individual’s shorter-term performance to help “predict” their future success would’ve been a poor decision-making tool. However, taking a longer-term focus by using each major winner’s overall world golf ranking (which reflects a body of longer-term work) was a helpful predictor of success, as each winner was ranked in the top 50 prior to his win and three of the four winners residing in the top 12.
What does this have to do with investing? Common investor behavior is to extrapolate the short-term performance of each individual asset class into a prediction of future outcomes. Compounding this mistake is that investors narrowly focus on each individual security’s performance, rather than keeping their eyes on the overall portfolio and its ability to meet their goals. For example, emerging markets and international equities haven’t kept pace in the short term and are being shunned by many investors because of their recent losses; however, a longer-term analysis suggests these asset classes can add performance and, importantly, diversification benefits to an overall portfolio.
2. Don’t overvalue par vs. birdie. This year majors brought low scores, highlighted by Henrik Stenson’s record-tying 20 under par to win the British Open. Stenson needed nearly every stroke to win a “shoot-out” with Phil Mickelson in the British Open. Remarkably, Mickelson, who is well known for aggressive golf, did not make a bogey in the final round, while Stenson carded two. However, Stenson’s birdie binge was enough to give him the victory. Similarly, Jimmy Walker’s win in the PGA was chalked up by many as a result of the three-foot par putt he made on the 18th hole; however, it’s worth noting that he was in that position only because he made a clutch eight-foot birdie putt on the 17th hole.
I worry that in the aftermath of the Great Recession, investors remain risk averse and view equities as too risky. Fixed-income mutual and exchange-traded funds continue to garner large inflows as investors shun equities.2 While this may be the right “answer” for some investors, I worry that many may be overemphasizing safety (par) at the expense of potential longer-term returns (birdies). While equities are typically subject to higher short-term variations, they historically have provided higher longer-term returns than fixed-income securities. Given the current low level of global interest rates, it is hard to imagine that most longer-term goals can be met solely on the back of the fixed-income asset class.
3. Consider hiring a caddie. In an era when satellites can relay distances and wind speeds, each major winner had a caddie who helped determine his overall plan and focused his emotions to enable him to make winning decisions. Reportedly, Jimmy Walker was standing in the 18th fairway and heard the crowd roar after Jason Day sank a putt ahead; he turned to his caddie and said, “Eagle?” The reported response from his caddie: “Doesn’t matter.” In other words, stick to and execute the plan.
Any financial professional will tell you to leave your emotions at the door when it comes to investing, but it seems all of us (investors and golfers alike) are susceptible to behavioral biases. Try your best to not let them get in the way of your long-term investment goals; and when in doubt, consult a professional.
1“Is Tiger Woods Loss Averse? Persistent Bias in the Face of Experience, Competition, and High Stakes,” American Economic Review, Feb. 2011, Devin G. Pope and Maurice E. Schweitzer. https://www.aeaweb.org/articles?id=10.1257/aer.101.1.129
2“The equity exodus by investors is getting worse,” Market Watch, 5.13.16 http://www.marketwatch.com/story/the-equity-exodus-by-investors-is-getting-worse-2016-05-13
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