"Settling for Par"

The New York Times published an interesting article on the economics of risk intolerance in golf. Using detailed statistics on 200 PGA Tour professionals from 2004 to 2008, a group of professors "found that birdie putts were made about 3 percent less often than otherwise identical putts for par." They say this is explained by a golfer's risk aversion to bogeys, and that it costs golfers approximately one stroke per tournament. The psychological effect of losing or making a bogey is stronger than that of making a birdie.

The same idea parallels to investing. People much rather make less (settle for par), than lose (risk a bogey). However, the point of the article was that golfers would benefit from taking more risk and being more aggressive rather than playing it safe on birdie putts. This is not quite the same in investing due to compounding returns. For example, if your portfolio experiences losses of 40%, it will take a turn around of 66.7% to get back to where you started. If you have half the risk exposure and lose only 20% of your portfolio, it will take a turn around of 25%. Half the loss requires roughly a third of the recovery. Winning by losing less.

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