Patience at the plate: how investing is like baseball
Even the best hitters strike out more often than they hit home runs. Consider the career of Ken Griffey Jr., a former outfielder who played 22 years in the majors.
Griffey, who is due to be inducted into the Baseball Hall of Fame this summer, hit 630 homers during his career, earning him a sixth-place spot on the all-time list. But the headline number doesn’t tell the whole story. His best homer-hitting years—which peaked with two straight seasons of 56 home runs—came during a five-year streak in which he also struck out more than 100 times per season. In other words, Griffey struck out nearly twice as often as he hit home runs.
Seeing Griffey step up to the plate during that run must have been exciting. Would he add another homer to his growing tally? Or would he fall to another increasingly common strikeout? One could just as easily have followed the other.
This kind of unpredictability can make for a dramatic day at the ballpark. It’s generally not as fun when it comes to investing.
But thinking about how a talented ballplayer could deliver both more homers and more strikeouts during a set period can help clarify the value of sticking with a diversified investing plan. It would be nice if every investment were a home run, but that’s unlikely. And strikeouts hurt. So instead of always swinging for the fences, it might make more sense to focus on trying to consistently hit singles and doubles.
Thinking about the previous inning
Investors are often tempted to invest in the “hot” fund or asset class, chasing where the returns were—and achieving unspectacular results. The problem is that no investment remains at the top forever.
To continue with the baseball analogy, investing in last year’s best-performing fund or asset class is a bit like expecting a batter to hit a home run just because he hit one in the previous inning. That’s generally not how it works. As the saying goes, past performance is no guarantee of future results.
For example, the chart below shows that emerging market stocks were the best-performing asset class in 2003, 2005, 2007, 2009, and 2012. Investors who decided at the end of 2012 to overweight emerging market stocks would have been in for a disappointment: They were among the worst performers over the next three years. The emerging markets are prone to delivering both home runs (leading the pack) and strikeouts (placing at the bottom).
Help Avoid the Past-Performance Trap With a Diversified Portfolio
Investors who pile into asset classes after they have risen, or who sell after they’ve fallen, are at risk of buying high and selling low. And that can hurt returns over time.
For example, the Schwab Center for Financial Research looked at the difference in the returns of mutual funds and investors in those funds over a 10-year period ending December 2015. It found that the funds’ annual returns were actually 1% higher than what investors in those funds earned, on average.¹ How could that be? It has a lot to do with how investors timed their investments.
If investors waited to buy in until after markets had already started rising and avoided investing when markets were down, they ended up missing out on gains. So their personal performance lagged behind the performance of the funds—that is, the results they would have achieved by staying consistently invested through ups and downs.
Singles and doubles
So what’s the alternative if chasing home runs isn’t a sound investment strategy? If you look at the chart above, you’ll notice a series of yellow boxes snaking through the middle. Those boxes represent the performance of a portfolio diversified across all the other asset classes in the chart.
If the asset classes in the top row represent the home-run investments of each year, and those in the bottom row are the strikeouts, then the diversified portfolio in yellow could be considered the product of a more balanced strategy focused on steadily knocking out singles and doubles.
That kind of performance may not be as exciting as risking everything on a never-ending—and highly unlikely—series of home runs, but over time it can allow you to steadily load the bases and drive runs in.
Or, if we reframe the baseball analogy slightly, having a diversified portfolio is like assembling a roster of different players with different strengths and weaknesses. You wouldn’t expect every one of them to hit a home run every time. Some will hit home runs, some will get base hits, and others will strike out. And some play excellent defense.
You may not know what will change with each inning—and each season—but the fate of your well-rounded team won’t hang on whoever made the last big play.
1. The analysis used Morningstar mutual fund data, focusing on equity mutual funds with a 10-year track record, comparing standard “time-weighted” returns and “dollar-weighted” returns. The time-weighted return measures the overall mutual fund performance, regardless of the amount of assets in a fund in any particular time period. The dollar-weighted return (which Morningstar calls “investor return”) reflects the performance of the typical investor in a fund, with more weight given to periods where more investor assets were in a fund. Morningstar total-return data typically doesn’t include sales charges (such as load and redemption fees) but does account for expense ratio, including management, administrative, 12b-1 fees and other costs that are taken out of assets.