What Can We Learn About Investing from March Madness?

Date: May 3, 2023
Category: Investment Returns, News & Events, Stock Market

Every year in mid-March millions of Americans flock to their televisions to watch dozens of games in the NCAA men’s basketball tournament. March Madness is such a popular sporting event that it is estimated that one-in-four Americans fill out brackets annually, attempting to pick the overall tournament winner and perhaps win some friendly wagers in the process. As much fun as it is to watch the tournament, cheer on your favorite teams, and test your prognostication skills, there are also some valuable investing lessons to be learned from observing the tournament’s proceedings.

Consistently Picking Winners is Difficult

To win tournament bracket contests, contestants typically have to successfully predict winners and losers more frequently than their opponents. After the first round or two of games, contestants then need to correctly predict the winners of matchups they believe are likely to occur, with little certainty they actually will occur. How difficult is it to correctly predict the outcome of all 63 tournament games? The odds of picking a perfect NCAA tournament bracket in any year is 1 in 120.2 Billion! Picking winning investments isn’t any easier. Most of the time the stock market is very efficient, incorporating new information into equity prices very quickly which makes it difficult to pick winners. Even professional portfolio managers struggle with picking winners. According to S&P Dow Jones Indices LLC which tracks the performance of active managers against index benchmarks through its SPIVA research, most Large Cap Domestic Equity funds underperform the S&P 500 each year. Since 2001 the average percentage of funds that underperform the S&P 500 annually is 64.63%! Over that 22-year timeline, the best year for active managers was 2007 when only 45% of managers underperformed the S&P 500. The worst year was 2014 when 87% of managers underperformed! All this should lead you to ask yourself if the professionals struggle mightily to beat the index what chance does the average investor have to beat the market?

Having a Strategy Improves your Odds of Success

You probably won’t win your tournament bracket contest because of the invariable upsets that occur each year, but the strategy of picking higher-seeded teams over lower-seeded should generally make you a winner more often than not. This strategy would certainly not have helped you very much in 2023 however with major upsets occurring frequently. The most notable upset saw 16-seed Farleigh Dickinson taking down 1-seed Purdue in the opening round of the tournament. With investing you can take an informed approach based on decades of academic research and reduce your risk by buying the market. The decades of returns data we have collected shows that US stocks have compounded at about 10% annually. Earning a consistent 10% annual return by buying the market is a reliable strategy that makes it much more likely you will achieve your financial goals versus trying to beat the market by picking the winning stocks in any given year.

Don’t Confuse Luck with Skill

It is a given that every year some fund managers will outperform the market index. But past data shows us that is very unlikely the same fund managers will come out on top year after year. This should lead us to conclude that fund managers who do outperform the market in any given year do so as a result of luck, not skill.

Every year in the NCAA tournament there will be upsets where much higher-seeded teams fall to lower-seeded teams. That’s part of the excitement of March Madness. But how many basketball experts would have predicted 16-seed Farleigh Dickinson would beat 1-seed Purdue in the first round? Very few experts would because the probability of that occurring is very small. The odds of a 16-seed beating a 1-seed in the opening round are so small, in fact, that it has only happened twice in NCAA tournament history! If you picked Farleigh Dickinson over Purdue in this year’s tournament you might ask yourself do you really have superior prognostication skills or were you just lucky?

What are the Stakes?

With the NCAA tournament, there is always next year. You might be out a few bucks if you entered a pool or placed a wager or two, but you get a do-over in next year’s tournament.

With investing, your results are cumulative. You don’t start over at zero next year. The really painful investing outcomes stick with you and make it that much harder to achieve your financial goals going forward.

In Conclusion

While many people find immense enjoyment in trying to predict the winners and losers in the annual NCAA men’s basketball tournament, sometimes the only way to be the big winner of a bracket contest is to take big risks by betting on underdogs.

With investing, you are far more likely to reach your financial goals by taking a proven and disciplined approach towards achieving higher expected investment returns while minimizing or reducing risk. Knowing when, and when you should not take on risk is often the difference between a successful and failed financial plan.

Sources: Dimensional Fund Advisors, S&P Dow Jones Indices, CBS Sports.com