Do it Yourself? Is it Worth it?
What is a professional basketball player worth? How does an NBA team decide how much to offer a star recruit? March is always exciting for sports fans with the NCAA basketball tournament. Along with enjoying the games, many players are also getting their best stage for displaying their worth to future NBA teams.
One key measurement of value is average points per game (ppg). The best player currently in college basketball averages 23ppg. The tenth best college player is averaging 20ppg, just three less. In the most recent draft the difference between the 1st and 10th players taken was nearly $3 million dollars. A team paid a lot of money, not for 23 points as one might assume, but just for those three extra ones. In investing, we call those three extra points the Alpha.
Alpha is used to compare a money manager’s value to the rest of the market. To say that a manager earned 15% last year only has value if compared to what everyone else did. The difference between his return, and the return of the markets in general, is what you are paying for.
Some years ago a brilliant man came in my office for some advice. He was officially retired, but was still spending about four hours daily managing his own portfolio. In the prior year he had earned 15% so felt his roughly 1000 hours spent in research had been time well spent. Still, he was supposed to be retired and his wife hoped he would spend more time with her enjoying life and less time watching stocks.
This led to a discussion about Alpha. I explained to him that he hadn’t really earned 15% for all his efforts, anymore than an NBA team gets a full 23 points from a star player, since the team could have saved millions by signing player number 10 and would only wind up with three points less. To determine how much value his 1000 hours brought him we compared his results, to what other portfolio management options would have returned to him, without any time on his part.
Retirement should be enjoyed. Managing an investment account takes a great deal of time, effort and worry. I personally couldn’t imagine doing all that I do in market research if I was only managing my own account. I admire those who do it, but wonder if the principle of Alpha that applies to basketball stars and investment managers might do well to also be applied to individuals. Ask the questions, how much am I really benefiting by all that time and effort? What could I be doing in retirement if I were not doing this? If you indeed really are that star stock picker who can pick up those three extra points, how much are you paying to obtain them in time, effort and worry, and is it worth it?
Three points to an NBA team can be significant. To an individual investor however, I have found far too many are putting in an awful lot of time for very little difference, if any, in the end.