When faced with an important decision, do you focus on risk or reward?
If you are anything like the typical hockey coach in the NHL, you probably focus more on what you stand to lose rather than what you gain from a risky decision.
Read this article to the end to learn how you can “play to win” instead of “playing not to lose” with your money.
Why “pull the goalie” in the first place?
When a hockey team is trailing near the end of the game, a common strategy is for the trailing team to “pull their goalie” and replace them with an extra offensive player. The hope is that an extra offensive player will increase the odds of scoring a goal and tying the game before time runs out.
A 2018 paper by Cliff Asness and Aaron Brown titled “Pulling the Goalie: Hockey and Investment Implications” builds a statistical model to determine the optional time a coach should pull their goalie. They also provide insightful commentary on what we, as investors, can learn from the mistakes of hockey coaches.
I won’t get into the details of the statistical model they build—but if that interests you, here’s the paper—Here is what they found.
In any 10-second interval of a hockey game, there is a 0.65% chance a goal is scored.
When one team pulls the goalie and adds an extra attacker, they have a 1.97% chance of scoring a goal every 10 seconds.
The opposing team has a 4.3% chance of scoring a goal every 10 seconds when the other team pulls the goalie.
If you’re not familiar with hockey, it may seem odd that the team with one additional attacker has half the chance of scoring a goal. The reason is quite simple; if nobody is guarding the goal, it’s much easier to score even if you have one less attacker.
As the researchers point out when a team pulls their goalie, they have less than half the odds of scoring compared to their opponent. This raises another question: “why would they pull the goalie at all?”
To answer that, you need to understand the incentive structure of a hockey team.
In the NHL, a team gets 2 points in the standings if they win, 1 point if they tie or lose in “overtime,” and 0 points if they lose in regulation. The objective of every team is to have enough points at the end of the season to make the playoffs.
If a team is down by 1 goal with two minutes left, they will probably lose. So, a goal to the trailing team has huge value because it would allow them to tie the game and guarantee at least 1 point.
But if you’re down one goal, pull your goalie, and the other team scores, you don’t lose very much because you were probably going to lose anyway, and it makes no difference if you lose by one goal or by two.
A loss is a loss.
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When’s the right time to pull the goalie?
As the researchers point out, most hockey coaches know that pulling the goalie will increase the chance the other team scores a goal first. As a result, they wait too long to do it.
According to Asness and Brown’s research, the optimal time to pull a goalie when trailing by 1 goal is 4 minutes and 20 seconds left in the game.
When a team is down two goals, the optional time to pull the goalie is with 13 minutes left in the game. A hockey game is 60 minutes, so pulling the goalie with 13 minutes left is unheard of in real life. Hockey coaches would never even consider it, even if it maximizes their odds of success.
In this way, hockey coaches have the wrong criteria for decision-making.
They focus on “not losing” rather than “winning”.
You might be wondering, what does any of this have to do with investing?
You need to make sure you are focused on the right risks
The hockey coach who waits too long to pull the goalie is more worried about not losing by 2 goals than they are tying or winning the game.
They choose a strategy that increases their odds of “losing a close game” than a strategy of “winning a close game or losing by a lot”. They would rather avoid the embarrassment of losing by a lot than maximize their odds of winning.
But guess what? If a hockey team loses a game by 1 goal or 10 goals, it still counts as one loss in the standings and hurts their odds of making the playoffs and competing for the Stanley Cup.
Asness and Brown argue that investors make a similar mistake as hockey coaches by focusing on the “wrong risk”.
Investors think about short-term risk. When considering a risky investment like stocks, investors focus on the volatility (potential to swing up and down unexpectedly) of the investment.
Investors should think about long-term risk. They should think about whether adding that “risky” investment increases their odds of achieving their financial goals over the long run.
Higher risk means higher expected returns in investing. Avoiding short-term risk by not investing in stocks creates long-term risk by reducing your odds of ever becoming financially independent.
You can pay a small price today by investing in risky assets or you can pay the big price down the line if you choose to play it “safe”.
Embracing investment risk doesn’t mean you should be reckless and bet your house on some penny stock or crypto coin.
Smart investors only take on risk if they are compensated with a high expected return on investment. Diversifying is the easiest way to ensure you get compensated for taking on risk. That means you own every company in the stock market through low-cost index funds.
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This article is for informational and entertainment purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.
Great post!