Why the World Cup can be a lesson for investors
THE drumbeat for the 21st World Cup nears. For a few blessed weeks from this Thursday, every qualifying country will dare to hope again - a statistically remote chance of raising the famous trophy, but never impossible?
Carefully calculated probabilities can help you guess at how many times your team would win if the game, or tournament, was played hundreds of times.
There is a useful lesson in this for investors. Hope, fear, even greed, can be deadly sins indeed when it comes to appraising investments. If a good decision should be based on a realistic assessment of the most likely outcomes, emotion severely hampers this process.
The media doesn't help, giving the most air time and column inches to the threats most likely to make us gasp (or just continue watching/reading) rather than those judged most likely.
A recent survey in the US found that people ranked tornadoes (which kill about 50 Americans a year) as a more common cause of death than asthma (which kills more than 4,000) – presumably because tornadoes make better TV, making it easier for people to recall their risks – something our behavioural finance colleagues call the availability bias.
Investors are daily faced with a multitude of economic and geopolitical bush-fires to assess. Most never develop into anything that warrants evasive action. A few do. History tells us that the world economy is simply much more likely to grow than not in any given month, quarter or year.
The returns from capital markets, particularly stocks, tend to follow this trend unevenly higher. This is because, much like global output, corporate profits generally reach new all time highs on a regular basis, and as a result so will share prices and (reinvested) dividends.
This means that excessive caution with regard to those various ever-smouldering bush-fires can leave you under-invested in a market that tends to rise over time a lot more often than it falls. On the other side, failing to protect sufficiently against one of the rare nightmares that actually becomes a reality can result in sharp and painful losses.
Investors in a portfolio well diversified across industries and asset classes can take some reassurance from the fact that such losses have been temporary.
Even those invested in high risk portfolios at the peak of the last cycle, before the worst recession and bear market in living memory, have now made their money back and much more – providing that they stayed the course.
Investors have spent the last couple of weeks grappling with exactly these dilemmas with regards to Italy. The still indifferent state of the Italian economy, allied to a surge in immigration, has provided populists and forces ambivalent or worse to the EU with rich stump box fodder. The Italian constitution still makes an exit from the EU a very unlikely eventuality, but recent months have certainly increased that small probability a little.
Portfolios should not shy away from risk to benefit from a continuing uptrend in corporate profits.
:: Jonathan Sloan (firstname.lastname@example.org) is a private banker at Barclays Wealth & Investment Management