How would you like to par every hole–and what does this have to do with investing? It turns out that parring every hole is a great analogy for a hard-to-grasp investing concept: getting market rates of return and being excited about them!
I have played several rounds of golf so far this year. During a recent round, I was excited to have a birdie putt and a couple of par puts (I didn’t come close to making any of them). At the risk of outing myself as a bad golfer, I ended my 9-hole round with a 51 and lost a dollar and my pride to my son. Time for him to start using the white tees!
I learned how to play golf when I was in graduate school. As I was a research assistant, the university covered my tuition, so I decided to take advantage by taking some fun, 1-credit courses along the way. One of those was golf (thanks, IU). I got pretty good pretty fast and even had a hole in one during my second year of play. It has been downhill or at least a long, steady plateau since then. I have very few pars, so having a couple of par putts that I completely blew brought to mind a talk I heard a CPA give at a conference a year ago. He discussed how getting market rates of return is like parring every hole.
As you likely know, I tend to favor a passive approach to investing — in other words, taking what the securities markets themselves deliver rather than attempting to “beat the market.” In the long run, this approach has been borne out by mountains of academic research. Taking what the markets deliver is how you put the academic concept called the Efficient Market (EM) hypothesis, or market efficiency, into practice.
The EM hypothesis more or less argues that all available information is already priced into the market and therefore, it is basically impossible to beat the market. Dr. Eugene Fama of the University of Chicago won a Noble Prize in Economics for this concept in 2013.[1]
Market efficiency is a hard concept to grasp and frankly one that is hard for me to explain and teach. It is not a numbers based principle (my bread and butter) but instead a theory and philosophy, so it can be hard to wrap your head around the idea. To make matters worse, once investors do understand about efficient markets and why it is futile to try to beat the market, they sometimes question whether they are just settling. Investors often think that by doing more research or hiring the best managers, they should be able to get better than market rates of return. Market rates of return are not exciting and instead downright boring. I have even heard it said that accepting market rates of returns is un-American.
All this is why I enjoy the golf analogy because it helps explain the EM hypothesis but also illustrates why you should be excited by them. Employing an investment strategy that utilizes funds that are engineered and structured to provide the return of the particular asset category allow investors to shoot par all the time.
When it comes to investing, just like in golf, there is confusion between market rates of return (investing) or par (golf) and average. Put another way, it is the difference between what you should get and what people often get. Golf helps highlight this difference – because par and average are far apart.
Merriam-Webster defines par as the number of strokes a good golfer is expected to take to finish a golf hole or course. Typical golf courses have par values of 72, yet most golfers (like myself) don’t ever come close to shooting par, with the average score being around 100.
Similarly in investing, the average stock mutual fund investor (as measured by the Dalbar, a Boston research firm) for the two decades through December of 2014 was an annual 5.19%. Contrast that with market rates of return; the figure for just the S&P 500 for the same period was an annual 9.85%[2]. Just like in golf, market rates of return (or par) are far apart from average!
So while I will likely never par every hole in golf (or even three holes in a 9-hole round), at least I know that when it comes to my investments, I am indeed parring every hole!
[1] To learn more about Dr. Fama and the Efficient Market Hypotheses, see the following article.
[2] For more information on the study see the following article.