Opinion and Investing Column

Kim: Investors must play to win to reach long-term goals

March 15, 2014

KimThe margin between the thrill of victory and the agony of defeat can be minuscule. Whether an athletic contest or the “game” of investing, many factors determining whether we win or lose are beyond our control. However, we can control how we approach the game and respond as events unfold, which can be just as important.

The U.S. women’s hockey team faced Canada in the gold medal game in Sochi. With Team USA leading 2-0 with less than 3-1/2 minutes to play, victory seemed assured. Alas, Canada would score the tying goal with 55 seconds to play and win the game and the gold in overtime.

It’s easy to find examples of players or teams snatching defeat from the jaws of victory. Whether from choking or playing not to lose, the result is the same. Fortunately, understanding that our response to the stress of competition has both mental and physical components can help us change our behavior.

That’s the message of Po Bronson and Ashley Merryman’s terrific book, “Top Dog: The Science of Winning and Losing.”

According to the authors, playing to win and playing not to lose are “diametrically opposing strategies, triggered by different psychological and physiological mechanisms. The hallmark characteristics of playing to win are an intensification of effort and continuous risk taking. The equivalent for playing not to lose is conservatism and trying to avoid costly mistakes. Under intense pressure, though, having a strategy of avoiding mistakes leads, by itself, to more mistakes. This is the paradox of playing not to lose.”

Further, “often biology and psychology are in a war for control. When biology gets the upper hand, your mind can’t turn the tide, and you are its victim, whipsawed by the effects of your body’s response. But when people say that the difference between an elite competitor and an intermediate competitor is all mental, that’s accurate: becoming a better competitor is about controlling your psychological state, which in turn alters your underlying physiology. Most simply put, if you can control your fear, then you can control your biology, too.”

For investors, the corollary to playing not to lose is loss aversion, an innate human trait also having emotional and physical components.

Behavioral finance research shows the pain investors feel from a loss is about twice as strong as the pleasure felt from an equivalent gain. To illustrate, assume if I offered you a bet on the flip of a coin that would pay you $150 if you guessed correctly, but cost you $100 if wrong. Since you have a 50-percent probability of winning $150 and a 50-percent probability of losing $100, your “expected return” on each flip is $25. Rationally, you should take this bet all day, but research shows most people won’t.

With today’s 24/7 media bombardment, when the market hits an inevitable rough patch, it’s easy to see how investors’ loss aversion can lead to panic and trigger short-term decisions harmful to attaining long-term goals. Trying to avert losses often leads to averting gains.

Investing is a marathon, not a sprint. As Warren Buffett said, “Games are won by players who focus on the playing field—not by those whose eyes are glued to the scoreboard.” Understand your biases and play to win.•

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Kim is the chief operating officer and chief compliance officer for Kirr Marbach & Co. LLC, an investment adviser based in Columbus, Ind. He can be reached at (812) 376-9444 or mickey@kirrmar.com.

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