The compounding of Roger Federer
At first blush, sports may not appear to have much in common with investing. But beyond being something to watch or participate in, sports can hold lessons for investors about achieving success over the long-term.
This summer, the Paris Olympics demonstrated the unpredictability and randomness of outcomes across different sports. Sports with more variables such as players, nets, posts and penalties are generally less predictable.
Sports with repetitive and objective events and relatively few variables have more predictable outcomes (think more points per game and more games per match). The outcome of any single point may be random, but it is relatively predictable that the more talented individual or team will win over the course of the competition.
As in sports, the short-term performance of the stock market is largely random. In the long-term, though, the key to success in both sports and investing is about putting the odds in your favour.
Tennis is a good parallel to investing. In a sport with fewer variables than most (often only two players and one ball) and many points required to win a match, career statistics from one of the greatest players ever demonstrate the power of compounding and consistency over the long-term.
In a recent commencement speech at Dartmouth, tennis great Roger Federer highlighted that he won only 54 per cent of the points over the 1,526 singles matches he played during his professional career. However, his small points-won advantage led to him winning about 80 per cent of his matches.
Mr. Federer’s winning percentage over his long career from 1998 to 2022 amounted to 103 singles titles, making him one of the most successful male tennis players ever. Yet, even with his talent, if Mr. Federer’s career had lasted only a few seasons, he would likely be a mere footnote in tennis history.
In investing, it is unrealistic to think that you will make performance-enhancing decisions even 60 per cent of the time. Many investors find this fact, and the fact that they will regularly make bad investment decisions, difficult to accept. However, like Mr. Federer, if you can consistently tilt the odds even slightly in your favour, it will lead to significant outperformance over time. The difference will likely not appear material in the early years, but can become very powerful later on.
Small advantages can make a big difference over time, but they are unlikely to play out consistently. In 24 years, Mr. Federer won 20 major titles – the Australian, French and U.S. Opens and Wimbledon. But in 14 of those years, he did not win a single major title.
Similarly, the share prices of even top-performing businesses do not outperform or even go up every year. As one example of a company with a stock that has outperformed over the long run, Amazon.com Inc. produced an annualized total investment return of 22.5 per cent over 20 years up to the end of 2023, more than doubling the S&P 500′s 9.9-per-cent annualized total return over the same period.
Despite this overall return, Amazon’s share price fell in six of those 20 years, in a period when the market fell in only three of the 20 years. In addition, Amazon underperformed the S&P 500 in nine of the 20 years, or 45 per cent of the years.
Many investors who owned shares of Amazon and other great companies 20 years ago may have sold them by now. For those investors, the long-term power of compounding has been interrupted by, for example, impatience or fear in response to a year in which the share price fell. This type of behaviour is one of the key reasons why most investors, including professionals, find it difficult to outperform the market over the long-term.
When you believe that you have purchased a piece of a great company at a reasonable price, you will generally be better off continuing to own it for the long run. This will tilt the odds in your favour by allowing your capital to compound, as Roger Federer’s playing statistics did over the course of his tennis career.