March Madness – that happy time of year when the drama and upsets of the National Collegiate Athletic Association (NCAA) basketball tournament intrigue even the casual fan – is here.
The tournament commenced on March 21 and will come to a close on March 30. As expected, hardcore basketball fans around the country have carried out the annual ritual of filling out tournament brackets with entry fees from $1 to $10,000, where they try to predict the outcome of the games.
A tournament bracket is a sequence of games between participating teams where the winner of each game progresses to play other winners until only a single team is left standing. Let us now take a look at ways in which March Madness compares to putting your money in stocks.
The “most probable” outcome isn’t always the most probable
The only time that all four #1 seeds progressed to the NCAA Final Four was in 2008, and only five times have three #1 seeds progressed to the national semifinals. One of the biggest mistakes that people often make when filling out their brackets is choosing too many top-ranked teams.
You cannot just count on the favorites because upsets are bound to happen in the tournament. The best brackets account for upsets by not picking the highly-seeded teams all the way through, and the same applies to the investing world.
For beginners, creating a portfolio consisting of only of blue-chip stocks is probably not a good idea. Each year, a list of the S&P 500 Index top-performers includes some firms that are barely thought of as top-tier companies, or at least some hardly known companies.
Although mega-caps such as Microsoft, Apple, and Amazon can anchor a portfolio, they should not constitute your entire portfolio. In other words, divide your portfolio among a variety of assets. Owning different asset categories, in particular non-correlated assets, lessens portfolio volatility.
People tend to focus on their emotional memory
March Madness fans tend to become more emotional about the outcomes of the games, the more they watch they watch the tournament. Watching the NCAA drama unfold on a widescreen from the comfort of your home is a great form of entertainment. The uncertainty surrounding the outcome of each game makes the tournament even more thrilling.
In the same way, investing in the stock market is exhilarating as investors may win big, lose everything, or anything in between. However, keeping a keen eye on the stock market can make you more vulnerable to making wrong investment choices.
According to behavior finance experts, there is a high chance that investors will see a loss if they check their investment portfolios every day. Investors tend to feel the pain of a loss far greater than they feel the pleasure of a gain. As such, they are more likely to stress out their investment strategy, or even worse, freak and sell everything.
History Might Mislead You
Nowadays, it is common to hear people say that “past performance is not an indicator of future results.” As many of you are aware, no #16 seed has ever defeated a #1 seed since the NCAA expanded the tournament to 64 teams.
It is true to an insignificant degree to say that #1 seeds are invulnerable. But assuming that every #1 seed has a 98% chance of beating a #16 seed, the latter still has a 7.8% chance of upsetting the former in any given year. That is probably a lot higher than you expected.
The same thinking is often applied when investing in stocks. Some investors don’t feel too comfortable automatically picking all of the top-performing stocks every year, even if they have consistently paid off for you so far.
Experts Often Get It Wrong
The odds of filling out a perfect bracket are 1 in 9,223,372,036,854,775,808. In spite of that, we still follow our favorite sports commentators waiting to know their picks as if they are omniscient.
Have you ever wondered why technical analysts, who are so confident about their forecasts, and market gurus, who write many books about the stock markets don’t make a fortune by simply making a trade in the market? Well, the answer to that question is simple: The so-called market experts are typically just a marketing tool used to reel in investors.
Predicting the direction of the market is just as impossible as predicting winners in March Madness. The reality is market upsets are bound to hit investors, but it’s impossible to know when they will happen.