Buy or Sell: The Perfect Analogy

The First Word:

Once or twice a week I like to take a late lunch break and head over to my parents house to eat and watch my favorite sports talk show, Around the Horn (no, I don't still live with my parents and yes, I am 24 years old and my mom still keeps my favorite lunch foods stocked for me… thanks Suzie). Anyways, for those of you who have never watched the show, the format is basically this:

Tony Reali, the show’s host, sits at a desk in front of four large screens. Each screen has a panelist that writes a sports column for one of the many newspapers around the US. The show is split into rounds in which the four columnists debate various sports topics of the day and are awarded (or penalized) points based on their arguments. After each round the panelist with the lowest point score is cut, and by the end of the show the last man (or woman) standing is awarded 30 seconds of facetime in which to talk about whatever he or she likes.

One of the show’s rounds is called Buy or Sell. In this segment Tony Reali reads off various sports news headlines from around the country and each panelist is given a chance to buy (agree) or sell (disagree) the headline. The columnist’s reasons for buying or selling a headline range from asinine, to well thought-out arguments. In the end, the scoring is completely subjective, and it is up to Reali whether or not to award points.

Buy or Sell:

Everyday there are dozens of headlines in the news about which way the US economy is going, or what company is about to make it or break it. From an investment standpoint, you can literally choose to buy or sell each headline if you like. In the investment world this is considered active portfolio management, and each columnist is an active manager trying to beat the market.

Much like the show, less than 1 out of every 4 managers who actively buys and sells headlines will beat the market. On top of that, chances are that the same manager won’t outperform the market year after year. While you can certainly watch the show and always root for the same columnist to win every day, you are essentially "putting all of your chips in one basket” and you will live and die on that columnist’s performance.

On the flip side, you can choose to watch Around the Horn because you think it is a good show and believe that it provides some value to your afternoon. While you might agree or disagree with each of the columnist’s opinions, they don’t change the fact that you enjoy the show and will continue to watch day after day. In the investment world this is equivalent to passive portfolio management. Although the performance of each show many vary, you remain confident in what the show has to offer.

1st Cut - Out of Bounds:

If I haven’t completely lost you yet, hopefully you are now thinking to yourself “okay, so how should I watch the show to get the most out of it (i.e. which is better, active or passive portfolio management)?" Short of giving out any investment advice (this is my non-disclaimer, you know, since I’m not giving out any advice)...

Watch the show because you like it and because you think it is good. If you come to the conclusion that out of the 4 panelists, you value the opinions of two of them and you think the other two are complete idiots, then start watching the show not only because you like it, but because you like two of the columnists.

If you do that, then for the most part you will ride the performance of the show. If it is a good show like you think it is, you will reap the benefits in the long run.

As for the part of you that watches the show in order to root for the two columnists that seem to actually know what they are talking about... If they collectively win more than the other two, than you will be ahead of the game in that regard. If not, at least there is still a large part of you that enjoys the show.

2nd Cut - Showdown:

To translate into english/investment talk (again, short of giving out any investment advice)...

A typical investment portfolio is made up of multiple asset classes. Most often, managers are chosen to to manage one specific asset class. If you know that one active manager will always outperform the market index for an asset class, then it would make sense to put all of your money there. Sadly, there is no way to determine this with absolutely certainly. As a result, a logical decision is to pick multiple active managers that you feel are better than the rest.

Still, this situation exposes you to the risk that both of these managers might make the same bad bets and under perform the market. In order to combat this, by allocating a portion of your portfolio to passive management, you ensure that some of your portfolio will follow the performance of the asset class.

By combining these two investment management philosophies, you are able to lower your exposure to risk through the passively managed portion of your portfolio, and still benefit from the possibility that the actively managed portion will outperform the market.

Facetime:

If this entire post is still confusing, you can try buying a few boxes of crackerjacks in hopes that they still put decoder rings in them or post a comment and I’ll try to clarify things as best I can. Chances are however, that I have also confused myself in an attempt to make this analogy work and I’ll just pretend to have never seen your comment...

Also, you can always just chalk me up as some idiot columnist who doesn’t know what he is talking about. Either way, I hope you continue to watch the show.

Goodbye:

"We're on a 23 ½ hour break!"

*Paper Toss*

-dunkie

p.s. you know that you've made a great analogy when you have to spend an equal amount of time explaining your analogy using non-analogies... good job me.