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BAM Intelligence

Focus on Your Own Game: Investing’s “Handicap System”

The handicap system in golf is one of the most unique developments in all of sports. It allows golfers of all talent levels – pros and amateurs alike – to compete on a level playing field on any given day. Using the system, a bogey golfer is awarded enough strokes in a round to generally offset the advantage of a scratch golfer’s superior skill.

When competing against an opponent with greater skill, it is critically important for a golfer to focus on their own game and resist trying to play at the same level as their competition. It’s a pretty fair assumption that a bogey golfer will be awarded a stroke against a scratch golfer on a 450-yard par 4. As such, the bogey golfer ought to play the hole like a par 5 and concentrate on reaching the green in 3 and making 2 putts for a net par. This prudent strategy requires the bogey golfer to suppress their ego, which can be a difficult task. As a result, many will instead elect to play for a heroic par (and net birdie).

For many bogey golfers, reaching that green in two will require a perfect drive, followed by a perfect fairway wood or long-iron, both very low-percentage shots. For a long-hitting scratch golfer, however, a 450-yard par 4 may be reachable with a driver and a wedge, both of which (due to talent and the shorter club) are much higher-percentage shots. While the bogey golfer inherently knows this, they often can’t resist channeling their inner Phil Mickelson and attempting to make the perfect shot anyway.

For every poor decision made by the amateur golfer, there is an equivalent made by the amateur investor. The “sure thing” investment is actually a sucker pin. Individual investors may double-down in an attempt to miraculously recover after a poor decision instead of taking the bogey and moving on. They may try something they saw on TV without studying or fully understanding the technique required to execute it. And they may credit talent when they make a great investment, but blame bad luck when they’re involved in a poor one.

Instead of pin-seeking at every turn, the amateur golfer can compete by simply laying-up instead of trying to fly the water, hitting a 3-wood or long iron off the tee instead of trying to cut a dogleg, or playing a pitch shot to the fat part of the green instead of attempting an extraordinary flop shot. Fortunately, the “safe” option is available to the individual investor as well.

In the same way that golf offers a method to compete when the odds are stacked completely against you, investing has its own version of the handicap system. The individual investor stands little chance if they attempt to play the same game as Wall Street and compete against high-speed traders. But implementing, and then sticking with, a solid asset allocation plan levels the playing field and offers a disciplined investor a system that allows them to succeed.

A well-constructed asset allocation plan considers the individual investor’s need to take risk, willingness to take risk and ability to handle risk. It is personalized to their own situation and the goals they are trying to reach.

The ultimate objective of managing your asset allocation is no longer related to beating a random index like the S&P 500. Instead, attaining a score of “par” is achieved by keeping your portfolio in line with your allocation targets and financial objectives, not somebody else’s.

If, for example, your plan calls for an allocation of 20 percent of your portfolio to large U.S. company stocks, your primary goal is to keep that portion of your portfolio aligned as it rises and falls with the markets.

Every investor knows they should buy low and sell high. The “rebalancing” process actually automates this process each time you bring your portfolio targets back into line. If the large-cap position outperforms and rises to 25 percent of the total portfolio, one or more of its other positions must have fallen below their original target. Rebalancing back to 20 percent requires you to sell that position higher than you bought it, and buy something that has been underperforming. Sell high, buy low.

This mentality changes the game. When the handicap system is used appropriately, the golfer can play a very successful round without achieving a score of par. Similarly, an investor can achieve a great investment experience by maintaining a proper asset allocation rather than trying to dig down and find the next great long-shot investment.

 

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The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2014, The BAM ALLIANCE

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Joe Pitzl, Partner, Pitzl Financial, LLC, Arden Hills, MN

Joe Pitzl, CFP®, is a Partner at Pitzl Financial. For over ten years, he has been helping individuals and families gain better clarity and control over their personal finances. He believes that money makes an excellent servant in life, but a horrible master.

Joe is a Certified Financial Planner™ professional and a graduate of the University of Wisconsin – Madison with a degree in Personal Finance. He is actively involved in the Financial Planning Association and is a past national President and Chairman of FPA NexGen.

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