SPidge Tales

Wednesday, August 15, 2007

The Stock Market vs. Sports

Boy meets girl. Boy asks girl out. Girl says no. Boy asks out new girl. New girl says no. Boy asks out yet another girl. Yet another girl says no. This happens to boy seven times. If boy is a pessimist, he is probably thinking, “I must have fell out of the ugly tree and hit every branch on the way down. I’m cursed. The next girl will say no, too.” If boy is an optimist, he is probably thinking, “I’m due for a ‘yes.’ I guess I gotta slay a few dragons before I get to my princess.”

Which attitude is better: pessimist or optimist? In reality neither. Either the next girl will like the boy, or she won’t. It will have nothing to do with the past seven girls. Think of a coin that comes up tails seven straight times after I call heads. If I were a pessimist, I’d feel doomed to keep flipping tails. If I were an optimist, I’d consider myself due for a heads. The next flip, though, will be 50/50 for heads (or tails). Odds don’t change based on the past.

In “A Random Walk Down Wall Street,” economist Burton G. Malkiel says that the Stock Market is as beholden to chance as that boy’s prospects with the next girl and the coin’s fate of heads or tails. Don’t put your money and trust in the hands of brokers and speculators, says Malkiel. Their guesses are about as informative as the local fortune teller.You can’t tell a company’s future prospects based on past sales. The “fortune 500” companies of 1900 are completely different from the top businesses of 2000. Don’t follow the speculators, either. They tell you to invest based not necessarily on what companies they believe will have good sales, but based on what companies they believe others will start investing in, causing the stock to go up. This leads to false value judgments for companies’ worth’s, ending up in large crashes, such as the tulip-bulb craze in 17th century Holland (http://en.wikipedia.org/wiki/Tulip_mania) and the United States’ stock market crash of 1929.

If we can’t “handicap” the stock market like horse racing, how are we to know what to invest in, short of insider trading and a quick trip to the Federal Pen with no passing of “Go” or collection of $200? The trick, says Malkiel, is to diversify your portfolio. But what does ‘diversify my portfolio’ mean? Well, most people, says Malkiel, invest in a variety of stocks that tend to rise or fall at similar times and in similar circumstances. For example, if you have stocks in an auto company and a tire company, if the auto company is going through a bad sales period, this will hurt the tire company, too, since a money losing car company won’t be buying many tires. Most people set themselves up in all-or-nothing spots, putting all their eggs in one basket, so to speak, despite their belief that holding stock in many companies protects them from financial loss.

Diversifying your portfolio means a helluva lot more than just investing in many stocks. It means investing in, yes!, DIVERSE—different—stocks, so that when certain stocks go down in value, you will own other stocks that go up, protecting your overall financial investment. Malkiel’s initial example is a desert island with two businesses, a hotel resort and an umbrella company. Let’s say that during sunny seasons, the hotel does good business, granting you 50% profit, or $0.50 for every $1.00 in hotel resort stock you own, but during rainy seasons, runs at a financial loss of 25%, losing you $0.25 for every $1.00 you invested in hotel resort stock. But fear not! During rainy seasons, the umbrella company turns a 50 profit, garnering you $0.50 for every $1.00 you invested. The umbrella company runs at a loss of 25% during sunny seasons, losing you $0.25 for every $1.00 in umbrella stock you own, but your hotel resort stock balances it all out, granting you an overall guaranteed profit of 12.5 cents for every dollar invested in all stocks, no matter the weather.

Granted, things are more complicated in the real world, where there are more than two companies, and more than just the weather affects the price of stock. But the trick is to set yourself up so that you own stock in companies that are built to profit during periods where other companies you invest in will fail, and vice versa.I think Malkiel’s approach to the stock market can be applied to other areas of life. If I go to a bar, I COULD try to mack it with the prettiest girl in the bar. But if she’s not impressed with the “made in heaven” tag I notice on her shirt or if she’s not impressed with my suggestion to walk by again in case of failure to believe in love at first sight, not only have I lost out on her, but I will probably have killed my chances with her slightly less hot (but probably still very attractive) friends flanking her, upset again that they go unnoticed in lieu of their hotter friend. Instead of chasing that “10,” I should put the moves on her “9.5” friend. This is a virtual ‘can’t lose’ situation. If the slightly less hot friend is receptive, I’ve still done well for myself. And if she’s not, no big deal. Her hotter friend is more likely to be receptive to me since she will see me as mature and concerned with more than looks (true, her friend is pretty, but she is prettier, and she knows it, so if a guy goes for someone else, he MUST care about more than just physical beauty). Or, she will be jealous that I went for another girl, making her HAVE to have me.

Malkiel’s diversified portfolio stock market theory is an excellent strategy for much of life, but--alas--it doesn’t work for everything. It has no value in the world of sports. We may THINK sports victories and losses can be attributed to chance. But we all know that sports are the one area of life beholden to superstition. You may think that no-hitters get broken up because a batter had a good hit or a pitcher threw a bad pitch, but in reality, every no-hitter is broken up because someone, somewhere, broke the taboo against speaking and mentioning that a no-hitter is taking place. You may think the Boston Red Sox went 86 years between World Series Championships because they never had the best team. No, they kept losing because of some curse caused by their owner in 1919 selling a fat baseball player to the New York Yankees. If coin tossing were a sport, the odds of a coin turning up heads (or tails) would not be 50/50. The odds would be biased in one way or another based on whether the head fans kept wearing the same dirty t-shirts they wore when heads first came up or the tail fans mothers promised to tape the championship coin toss but later accidentally taped over the video when they HAD to save the latest episode of Grey’s Anatomy. Thankfully, the stock market is not a sport and not beholden to superstition.


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