What Baseball Can Teach Investors

There is great value in identifying principles that produce success in one activity and applying them in another. Investing has been described as a game, and it does share many of the characteristics of games or, indeed, any pursuit that requires the use of strategy. Of course, the level of applicability of principles will vary by activity. I believe the game of baseball is particularly well suited to providing useful lessons for better investing as discussed in the paragraphs below.

GOOD PITCHING BEATS GOOD HITTING

This old chestnut is recognized as a truism by any seasoned baseball fan. Time after time, one sees a great hitting team shut down by an opposing team’s top starting pitchers. This concept is related to another old sports cliché that “defense wins championships”. The importance of a strong defense is recognized across all team sports. The reason defense possesses the advantage is that it is an easier strategy to implement than offensive action, which typically requires surmounting a greater number of obstacles to succeed. In baseball, scoring a run requires, except for the home run, multiple hits and/or walks as well as running the bases efficiently. The defensive team needs only to catch the ball. Defense is also recognized as having the easier role in warfare; most military thinkers recommend at least a 3 to 1 advantage by the attacking side to produce a high probability of success.

For investors, a sound defense rests with prudent money management. Prudent money management requires that position size should be kept small enough that losses, or indeed a string of losses, will not have a material impact on the portfolio. Batters can both go on hot streaks and endure painful slumps, and so can investors. Adopting a defensive posture with appropriate position sizes and having a policy in place to limit losses is integral to increasing the odds that an investor will reach the end of his or her investing “season” with satisfactory results. It is well to remember that a portfolio that declines by 50% must then rise by 100% to reach breakeven. The mathematics of investing makes clear that “defense wins championships.”

BALLPLAYERS ARE OFTEN MOST VALUABLE BEFORE THEY PLAY A MAJOR LEAGUE GAME

The vast majority of minor league baseball players, even the most highly regarded, will not succeed at the major league level. Every baseball fan has seen an array of “can’t miss” minor league prospects fail to make an impact in the majors. In fact, fewer than 20% of prospects become impactful big-league players. However, highly regarded minor leaguers are highly sought after by other teams who will often trade established major league players for one or more “prospects”. The appeal of successful minor leaguers is that their futures are unsullied by failure in the major leagues. The perceived potential of these players is limited only by the imagination of observers.

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The Global Investment Letter is a monthly journal of ideas and opinions about capital markets. Global macro ...

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