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
Having a Strategy Improves your Odds of Success
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.
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