7 Lessons the World Cup Offers on the Stock Market

You can learn a lot from watching the World Cup–and not just about soccer. As I've tuned into the games I've started to realize how many ways it's just like the stock market–and how it can actually teach you a useful thing or two about making money.

Don't believe me? Here are seven lessons that "the beautiful game" can teach you about the money game:

1. Don't be shocked by "shocks."

Who would imagine that France, finalists four years ago, would crash out in such humiliation? That England would draw with Algeria? That Switzerland would beat Spain?

Yet these "shocks" happen all the time.

Many years ago, when I wrote a book about futures betting on soccer, a top bookmaker in London told me his firm made good money on unlikely events such as these. The gambling public, he said, typically underestimates the chances on an upset.

And so it is in the investing world. Nassim Nicholas Taleb calls such unlikely events "black swans." As English comic novelist P.G. Wodehouse once put it, "never confuse the unusual with the impossible." Not long ago it seemed impossible that, say, Lehman Brothers or General Motors could go bankrupt.

As we have been reminded in recent years, the unusual happens. The only thing surprising is that so many people are surprised.

2. You need a strong defense.

Getty Images

England's goalkeeper Robert Green reacts after missing a goal last week.

There's a saying in soccer: "It only takes a second to score a goal." But as England's hapless goalkeeper, Robert Green, could tell you after his schoolboy blunder against the United States last week, the truth is slightly different.

It only takes a second to concede a goal. Scoring one at the other end can take forever.

Investors know how it feels. The profits of a brilliant trade can be thrown away in a moment by a careless blunder.

Offense, trying to make money, is much more exciting than defense, trying not to lose it. But smart money management starts the other way around. After all, it takes a 100% profit to recover from a 50% loss. Or as value investors might put it: Rule number one, concede no goals. Rule number two? Never forget rule number one.

3. You have to think globally.

The World Cup is one of the few times fans everywhere drop their obsession with the sporting events, players and teams at home and start to pay close attention to everyone else.

Sure, you're rooting for Team USA. And the Japanese have been rooting for Japan, and so on. But everyone knows the biggest stories are teams like the Argentinians, the Portuguese and the Brazilians. And we're all watching anyway.

Investors need to learn the same trick. "Home equity bias" has long been identified as a big problem in most portfolios. Most people keep way too much of their money in their home stock market. Studies have found that U.S. investors typically keep more than 80% of their equity portfolio in U.S. stocks. According to the Investment Company Institute, fewer than half of households that invest in mutual funds even own a fund that invests overseas.

It makes no sense. You already have big economic bets on the U.S. economy–your home, job and support network are all here. The U.S. only accounts for a third of the world's stock markets by value, so if you just stick to the home market you're missing out on two-thirds of the action.

Investing globally spreads your bets and gives you maximum diversification. A recent paper by AQR Capital Management, found that a global portfolio has typically given investors better long-term returns with less short-term turmoil.

4. Don't get blinded by hope.

I understand why someone from North Korea would choose to cheer for North Korea (0-for-2, nine goals allowed), no matter how badly the team does. After all it's their country.

What I don't understand are investors who stick with terrible investments all the way down, hoping and praying that bad management, bad strategy and bad products will somehow produce a good result. Hoping isn't expecting. Unless they actually worked at the company, no one needed to be stuck with their shares in Washington Mutual or Fannie Mae or General Motors. If it's not making you happy, stop complaining or praying. Sell.

5. Patience wins.

Once again the England team has proven, so far, a monumental disappointment to its fans at home. I used to live in England and watched this happen, oh, every four years.

Brazilian soccer legend Pele once explained the problem to a British TV reporter some years back. England, he said, needed to develop patience on the field.

They aren't alone in this. Too many teams try for the quick kill–kicking the ball up field and hoping for the best. Great soccer teams–especially the Brazilians–take a very different approach. They are famous for passing the ball around dozens of times, waiting for just the right moment to strike. It works.

And so it is on the stock market, which Warren Buffett–possibly the Pele of investment–once called an efficient mechanism for transferring money from the active to the patient. Like most great investors, he'll bide his time almost indefinitely, waiting for the chance on goal. It's a better plan.

6. Watch your margin of safety.

The Slovenians looked pretty comfortable after securing a two goal lead against the U.S. half way through the match. But in the end they were lucky to escape with a draw. These kinds of turnarounds happen all the time. You can't get too comfortable. Almost anything can happen.

Ben Graham, the godfather of cautious "value" investing, reached a similar conclusion about his portfolio after the crash of 1929. Stock prices plummeted far further than he ever thought possible. (Real estate investors in the past few years have had a similar experience). That's why Mr. Graham turned his attention to the concept of "margin of safety." He recommended investors buy stocks when they are at least a third below their intrinsic value. Just in case.

7. Don't pin all of your hopes on the referees.

Financial regulators–including the Securities and Exchange Commission, the Treasury and the Federal Reserve–have come in for severe criticism in the wake of the financial crisis, and no wonder. They didn't believe there was a housing bubble. They didn't know the banks were playing shell games with their balance sheets. They didn't know what was really going on in the derivatives market. The list is pitiful.

But if they want to feel better about themselves, they should probably tune in to some of the World Cup matches. Some of the refereeing has been simply extraordinary. First-time referee Koman Coulibaly has been left out of the next round after the controversial, and probably blown call in the USA-Slovenia game that cost the U.S. a win. It wasn't the only controversy of the Cup. And if experience is any guide, it won't be the last. Dubious refereeing is as much as feature of soccer as it is of the stock market. As for Mr. Coulibaly: Maybe we could find him a job on Wall Street–as a regulator.

Article by: Brett Arends - http://online.wsj.com