The Hail Mary: a long, desperation pass from a quarterback to win a football game that would otherwise be lost. It’s one of the most exciting plays in sports as its outcome is binary: the team throwing the Hail Mary either instantly wins it all or loses everything. Its chances of success are also extremely low (hence the term Hail Mary—a prayer). One of history’s most famous Hail Marys was Doug Flutie’s 65-yard heave during a 1984 college football game, which gave Boston College a win over the University of Miami in the final seconds. It immortalized Flutie mainly because the odds were so stacked against its success. Flutie connected, but the vast majority of Hail Marys end up on the scrap heap of history.
Investors often take the same gamble, but the consequences can be far more devastating than a lost football game. After experiencing a streak of losses that landed him in the hospital due to the stress, Montreal-based trader F.S. Comeau made an epic bet a few weeks ago that Apple would post weak quarterly results. Mr. Comeau took his life savings (about $250,000) and bought a series of put options positioned against Apple’s results. If Apple earnings disappointed he would net a few million; however, if they were strong…poof! bye-bye life savings. The pivotal price was US$128. If Apple shares hit this level post-results the trade would fail. Apple, unfortunately for Mr. Comeau, impressed the market and the shares closed the next day at US$128.75. Some are saying it was a hoax, but if not, I’m willing to bet he’s now back in the hospital.
You have to admire Mr. Comeau’s bravery, but trying to complete a Hail Mary with your life savings is about as prudent as wearing a live mic and walking on to an Access Hollywood bus with Donald Trump: it’ll be exciting at first, but it won’t end well (ask Billy Bush). However, these high-risk investor moon-shots occur constantly. It’s an incredibly strong human impulse to attempt to instantly make up for losses. It’s how gambling addictions develop and it’s how investors squander their hard-earned savings.
Whether they’re blinded by desperation or overconfidence, attempting to immediately reverse losses leads many investors to ignore baseline probabilities. With respect to the football Hail Mary, ESPN Stats & Info calculates the odds of a successful completion at only about 10%. For investor Hail Marys, the odds of success are usually just as dismal.
The only way to rapidly move your investments from the red to the black is to take on more risk, usually in the form of more leverage or more security concentration: fewer and riskier stock picks, for example.
Naturally, such strategies are unwise. To illustrate, take a look at some of JP Morgan’s number crunching. JP Morgan examined the price action for securities in the Russell 3000 Index, a broad-based index of US equities, and showed that, over time, the odds of any one position experiencing a catastrophic loss—a decline of 70% or more from the peak with minimal recovery—were 40% and in some riskier sectors, such as information technology, the odds rose to nearly 60% (see table).
If you held a portfolio of only, say, three or four stocks, essentially throwing your Hail Mary, imagine how devastating it would be to have even one of these positions plunge 70% let alone two? Even apparently safe, well-established companies find ways to self-destruct, which can devastate improperly diversified portfolios. And if you think that catastrophic losses don’t apply to the Canadian equity market consider our notable trail of tears: Nortel, BlackBerry (Research In Motion), Bombardier, Yellow Pages and Valeant Pharmaceuticals to name but a few. Let’s also mention our market’s countless junior oil & gas and mining companies that are now six-feet under (Bre-X—another beauty).
Flutie flung his Hail Mary pass because it was the only option available. As an investor, you have many choices and can recover losses with far better odds if you exercise patience and maintain a balanced and globally diversified portfolio.
And proof that a Hail Mary is essentially a gamble? Flutie wasn’t even initially aware of who caught his pass (it was historical-footnote receiver Gerard Phelan). Don’t risk delaying your retirement, or diminishing an existing retirement, by trying to throw up a prayer. Prayers are for churches, not portfolios.