Filling out a bracket for the NCAA championship basketball tournament is an annual highlight for sports fans like myself. Like most people, I don’t watch much of the regular season games, but every March I start reading expert picks and researching bracket strategy in preparation for pools with my family and friends.
The process reminds me so much of investing because filling out a bracket balances expertise, risk, reward and future expectations. Winning a pool also requires some luck along the way.
With that in mind, here are five lessons from March Madness that apply to the world of investing.
The odds of filling out the perfect bracket are 1 in 9,223,372,036,852,775,808. Let’s just round that to 1 in 9 quintillion. The odds of consistently selecting market beating investments over a long period of time are equally daunting.
The key to successful investing is about focusing on the things you can control. From an investment perspective that means building a portfolio that is positioned to capture return premiums (such as size, value, and profitability) that improve risk-adjusted returns. Other areas of focus that are within your control include asset allocation, keeping investment costs low, minimizing taxes, optimal asset location, etc.
It is easy to let a team’s recent success influence your bracket picks, but last year’s tournament was last year’s tournament. Similarly, investors should never assume that their best pick (asset class, sector, country, or stock) from last year will have a repeat performance.
In addition, the winner of your bracket pool might be skillful, but he/she might also just be lucky – there is no reason to believe that success will be repeated in the future. The same goes for mutual fund managers, their outperformance in any given period may be the result of skill or luck – in fact, it is quite common to see funds that have outperformed in a given period proceed to underperform in the subsequent period.
The more you watch the NCAA tournament, the more emotional you become about the outcomes. Watching the drama of March Madness is a great form of entertainment, but watching the market closely almost never helps an investor.
Myopic loss aversion tells us that the more you watch the markets, the more susceptible you become to making poor investment decisions. The best investors stay as detached as possible from daily stock fluctuations.
Humans are hardwired to see patterns and our tendency to only remember the times they work only engrains that pattern seeking behavior. For example, I always pick a #10 seed to upset a #7 seed based on my perceived frequency of that type of first round upset occurring in the past, but not based on any background knowledge of the skill sets of the opposing teams. Another example is picking your alma mater or a local school to advance further than what evidence and probability suggest.
Investment decisions should not be based on technical indicators, patterns or hunches. Instead, a quality decision making process emphasizes evidence-based investment theory and research. A quality decision making process should also protect us from our faulty mental hardwiring that causes us to misinterpret (or ignore entirely) probabilities, find patterns where none exist and elicit emotional responses.
Chances are that many winners will attribute their success to skill and leave out the role that luck played in the outcome. For example, some people who win their pool by taking an extremely risky approach of picking lots of low probability upsets and having several come to fruition by chance. People that take this approach every year will frequently finish near the bottom of the standings, but they never mention those bad years.
Other winners might fill out multiple brackets, compete against only a handful of people or simply make their picks by blending together multiple expert brackets. Still, all of these people will undoubtedly share their success through the lens of skill when a conversation arises about March Madness. Conversations on investing in social situations work much of the same. I always hear people talking at social gatherings about their investment successes, but never do I hear about their failures.
From Forbes March 2017 Peter Lazarof, https://www.forbes.com/sites/peterlazaroff/2016/03/17/5-investing-lessons-from-march-madness/#ebcbba62b752