The World Cup is at its semi-finals stage now and the matches are getting really exciting (Brazil vs. Germany and Netherlands vs. Argentina!). But when you’re catching the matches, take a look at the footballers trying to win a header from a goal kick; they’re doing something extraordinary. A ball was kicked maybe 50 to 80 metres away, coming off the feet of a player at about 110 kilometres per hour. In less than five seconds a player has to run to the exact location where the ball lands, down to the centimeter, and head it away without a blink…
The World Cup is at its semi-finals stage now and the matches are getting really exciting (Brazil vs. Germany and Netherlands vs. Argentina!). But when you’re catching the matches, take a look at the footballers trying to win a header from a goal kick; they’re doing something extraordinary.
A ball was kicked maybe 50 to 80 metres away, coming off the feet of a player at about 110 kilometres per hour. In less than five seconds a player has to run to the exact location where the ball lands, down to the centimeter, and head it away without a blink to spare.
This is extraordinary because of what he needed to figure out in those five seconds. He had to know the ball’s initial velocity, spin, and angle. He had to know the exact speed and direction of the wind, since it would alter the ball’s trajectory. He had to know exactly when the ball would switch from vertical ascent, lose speed, stall for a moment, and begin its decent. The calculation necessary to know where a ball will land is a monster (just see the chart below):
This is nearly impossible to calculate in your head. Yet sports players do it all the time. According to Inside Edge, 84.7% of baseballs that hang in the air for five seconds end up with a player catching it while it’s still in the air. Stephen Hawking could not calculate this equation in five seconds, but you see baseball players do it thousands of times.
Players don’t actually do this calculation in their heads, of course. In his book Risk Savvy, Gerd Gigerenzer writes that, whether they know it or not, baseball players (and probably footballers as well) use a rule of thumb to know where a ball will land:
1. Align a flying ball in the center of your gaze.
3. Adjust the speed and direction of your run so the angle of the ball stays at the same spot in your gaze.
That’s it. As long as the ball’s angle remains constant in your gaze, you’re running to where it’s going to land. All the complicated math is captured in that rule of thumb.
Baseball players (and footballers) intuitively understand something more investors should: complicated problems can be tamed with simple rules of thumb. And the more complicated a problem is, the lower the odds you’ll calculate it with precision, making rules of thumb indispensable.
Thirty years ago, Pensions & Investment Age magazine made a list of money managers with the best 10-year returns. Few had ever heard of the winner, Edgerton Welch of Citizens Bank and Trust, so a Forbes reporter paid him a visit. Welch said he had never heard of Benjamin Graham (the intellectual father of the value investing philosophy) and had no idea what modern portfolio theory was. Asked his secret, Welch pulled out a copy of a Value Line newsletter and told the reporter he bought all the stocks ranked “1” (the cheapest). The rest of his day was leisurely. His only secret was taming a complicated problem — which stocks should I own? — into an effective rule of thumb: the cheap ones.
Investors should use more of this kind of thinking. Markets are endlessly complicated, investors are endlessly emotional, and there are no points awarded for difficulty. Overthinking things like valuation and modern portfolio theory can be the equivalent of a footballer pulling out a calculator after each ball is kicked, desperately trying to track its landing point with precision. Any time you can tame a complicated system into a simple rule of thumb, you will be better off.
How to keep things simple
Don’t try to calculate when you should buy stocks. It’s too complicated a problem with too many unknown variables. Instead, dollar-cost average, buying the same amount of stocks every month or every quarter, rain or shine. Over time you will beat almost everyone who doesn’t follow this approach.
Don’t try to calculate what the market might return over the next year or two. You’ll never figure it out. Instead, assume it’ll return 7%-8% a year over a multidecade period – with a lot of volatility in between – because that’s what it has done in the past (the Straits Times Index (SGX: ^STI) has a compounded annualised return of 5.26% since the start of 1988 to its current level of 3,282 points; throw in 2%-3% of dividends per annum and you end up with a return of 7%-8% a year).
If you do try to predict shorter-term returns, use the rule of thumb that the worse the market has done over the last 10 years, the better it will do over the next 10 years, and vice versa. Over time this rule of thumb will humble nearly every investment strategist.
Rebalance your mix of stocks and bonds every few years. Don’t put any extra thought into it.
Don’t try to predict when we’ll have another recession. No one can. Instead, use a rule of thumb that we’ll have three or four recessions at random times every 20 years.
Prefer companies that reward shareholders with consistent dividends and share buybacks. Trying to calculate whether a chief executive is effectively reinvesting profits in his or her own company is hard, and evidence is persuasive that most are bad at it. Cash handed to you directly is more likely to accrue in your favor over time.
Don’t try to calculate exactly how much money you’ll need to retire. You have no idea what the future holds. Instead, save at least 10% of what you make, and as much as you can while still living comfortably.
Foolish Bottom Line
You might think successful investors are brilliant minds who can calculate complicated things with precision. They rarely are. The best are more like baseball players and footballers, able to solve complicated problems by using simple rules of thumb. “Simplicity is a prerequisite of reliability,” said Edsger Dijkstra. Try doing less.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. This article was written by Morgan Housel and first published on fool.com. It has been edited for fool.sg.