Have you ever played a round of golf where you end the round saying, “If only I didn’t quadruple bogey the 2nd and 11th holes, I’d have shot my personal best!”. It’s uncanny how a couple of bad holes can negatively affect your overall score. Tracy Fiedler of Invesco recently blogged about how investors should think of this when scoring their portfolios.
Tracy compared and contrasted the way golf is scored to the way the NBA playoffs are scored. In the NBA playoffs, a team must win 4 games of a 7 game series to advance. It doesn’t matter what order those wins come in or by what amount. The saying, “A win’s a win”, comes to mind. The same does not apply on the golf course. As mentioned above, a few bad holes in golf can really mar your scorecard. This is not much different than an investor’s portfolio:
“Mistakes on just a hole or two can ruin an otherwise well-played game. Likewise, it may just take one or two exceptionally bad years to push your investment portfolio off the path to victory.”
This reminds me of something Ed Easterling discusses in his book Unexpected Returns: the impact of negative numbers. When it comes to compounding returns, it takes a greater positive return than the offsetting negative loss to break even. For example, if you start with $100,000 and gain 20% one year only to give back 20% the next year, you’d be left with $96,000 not $100,000.
This is why investors should measure their success like golfers. A portfolio should be prepared to handle offensive and defensive periods in the market because they will both undoubtedly occur.