Blogs | May 23, 2011

What football can teach us about investing

When interest rates are very low, some argue we must “do something” to get a decent return on cash savings. The world of football offers some perspective on this conundrum.

When the football season is almost over, we can look forward to the usual spate of sackings of managers. We can also look forward to something else too – that such sackings, on average, won't work.

Yet there is robust evidence from the Netherlands, Italy and Belgium that changing the manager may do nothing to improve team performance. This corroborates billionaire investor Warren Buffett's famous saying: "When a boss with a good reputation joins a firm with a bad reputation, it is the firm that keeps its reputation."

If sacking managers doesn't work, why do club owners do it?

Sometimes it's better to stand still
One reason lies in another strange aspect of football – how goalkeepers fail to save penalty kicks. A team of Israeli economists have found that keepers very often dive either left or right although they would have more chance of saving the kick if they stood still. So why do they move? It's because of the action bias.

When we are faced with uncertainty, we feel the need to do something. Just as goalkeepers feel the need to dive, so club owners feel the need to change manager. There's a second reason, which arises from one of the most ubiquitous irrationalities of all – overconfidence. We tend to believe that our next big decision will be right – even if our past decisions have been stupid. So club owners think they can find the right manager, even though the previous appointments were duds.

In investing, is being active better?
Football club owners are not uniquely ill-informed – we are all prone to make the same mistakes they do. And these mistakes can be costly.

A classic paper by Terrance Odean and Brad Barber, two US economists, found that the most active share market investors on average earned lower returns than less active ones. The same researchers found in a different paper that overconfidence – the belief one can spot the next winning stock – can also lose us money. This can be dangerous, and not just for equity traders.

How to respond to poor performance off the field
When returns on cash tend to be negative in real terms, a reason can be that short-term interest rates are below the inflation rate. It's tempting to respond to this poor performance in the same way that football club owners respond to a poorly performing manager – by getting rid of him.

Think twice when this temptation arises. For one thing, cash can be a relatively safe asset. Given that inflation doesn't vary much when compared with movements in share markets, maximum loss is probably only a few per cent. Shares and commodities are so volatile that it is quite possible to suffer much larger losses.

Interest rates are low for a reason
And for another thing, low expected returns on cash should, in theory, mean low expected returns on other assets, especially shares. Interest rates are low when central bankers are pessimistic about the outlook for economic growth (just as interest rates can be high when the growth outlook is strong). And poor economic growth could mean poor returns on shares.

Low interest rates in themselves, then, may not be a reason to change your investment policy. Doing nothing can be perfectly reasonable. Remember the words of French philosopher Blaise Pascal: "All human evil comes from a single cause: man's inability to sit still in a room."


Chris Dillow
Chris Dillow

Investors Chronicle writer and economist