Investing Lessons From March Madness

Beginning this Thursday, there will be 48 college basketball games played over the course of four days as part of a 68-team, single-elimination tournament to determine an NCAA champion. This wonderful sporting event is affectionately referred to as March Madness.

As a sports fan, this upcoming weekend is one of the best of the year. Even if you’re not that into sports, the next few weeks are still a fun time as many non-basketball watchers will fill out a bracket with hopes of beating their friends or winning their office pool. Approximately 40 million people fill out March Madness brackets each year.

One of my favorite stats is that an estimated $13.8 billion is lost by companies every year as work productivity torpedoes on Thursday and Friday (the first two days of the tournament) with the average worker admitting to spending six hours watching games during work hours each year.

I wrote about this last year too, but there are actually quite a few parallels between “bracketology” and investing.

So, as you fill out your own bracket this week, here are some lessons from March Madness that you can also apply to become a better investor.

#1: Forget Perfection

According to NCAA.com, the odds of picking all 63 tournament games correctly and filling out a perfect bracket are 1 in 9,223,372,036,854,775,808. That’s 9.2 quintillion. For reference, one quintillion is one billion billions.

In the history of the men’s tournament, no one has ever filled out a perfect bracket. The closest anyone has come, at least that’s known publicly, was a guy who predicted the first 49 games correctly in the 2019 tournament before eventually stumbling.

The odds of picking individual stocks that will consistently outperform the overall market may not be quite as preposterous as filling out a perfect bracket but are similarly daunting.

Over the past 90 years, only 4% of all stocks accounted for the entire gain created in the U.S. stock market, while the other 96% of companies barely kept pace with inflation.

Since 1980, more than 40% of all companies in the U.S. stock market have experienced a decline of 70% or worse without recovering. Meaning that over the past 40 years, you basically had a 1 in 2 chance of picking a stock that would lose almost all its value over time.

If you look through any market report for any equity market on Earth, you’ll see more or less the same thing — over a five-year period around 75% of actively managed funds don’t beat their benchmark. Around 95% of professional day traders end up losing money over a five-year period as well.

“But my employer stock is different…”

Is it?

Just as going all-in on a 14-seed to make it to the Final Four will destroy your bracket when it likely doesn’t happen, buying individual stocks offers the potential for higher returns but also opens you up to big risks.

To use a metaphor from a different sport, being diversified means you’ll miss out on some home runs but it also means you’ll never strike out. And not striking out is the key to letting compound interest work its magic in your favor.

“Average returns sustained for an above-average period of time leads to extraordinary results.” — Morgan Housel

#2: Past performance doesn’t guarantee future success

Since 1973, only two teams have won back-to-back men’s national championships. Duke in 1991-92 and Florida in 2006-07. It is very rare that the best team from a previous year carries over into the next.

One study showed public expectations for how far a team would advance were heavily based on their performance in the tournament a year prior. However, past tournament success or failure was found to have no correlation to current performance.

A recent example was in the 2018 NCAA tournament where, in one of the most shocking results in tournament history, Virginia became the first ever 1-seed to lose to a 16-seed. The following year they were a 1-seed again but were the least-picked favorite due to their flame out the year prior. Yet, just a year after their first-round loss, they ran the table and won the national championship.

Likewise, investing based on previous performance has generally led to disappointment.

Standard & Poors has a study that looks at the consistency of the top-performing mutual funds. The study found that for all U.S. funds that were in the top 25% of performance in 2019, only 4.8% of those funds remained in the top quartile after two years. This pattern repeats itself year by year.

We’ve seen this with tech stocks over the past couple of years. For the better part of the 2010’s it felt like technology stocks were untouchable. But then in 2022, many of these same companies came crashing back down to earth giving up almost all of their gains. These are some of the biggest and best companies on the planet, but stock prices can only go so high before gravity kicks in.

There’s an old saying that nothing fails quite like success on Wall Street.

One of the few dependable features of investing in the stock market is that it’s cyclical. There is no strategy that always works all of the time. Investors that spend their time searching for the best-performing investment are usually chasing past performance which results in continuously being one step behind.

#3: Winners tend to ignore the role of luck

When March Madness is over, chances are many of the winners of their bracket pool will brag to their friends about how “they knew it!” which is part of the fun of making a bracket. When you win you get bragging rights over your friends and can say you knew it all along. But in reality, no one knows exactly what will happen. We all just make guesses, even if they’re educated ones, and hope that the ball bounces in our favor.

Conversations about stocks and investing in social settings work much the same way. You’ll always hear people talk about their winners and they’ll give a reason why their particular investment performed well; however, they always happen to forget to mention their failed investments. Luck and risk are two sides of the same coin.

“Even if we acknowledge ahead of time that an event will combine skill and luck in some measure, once we know how things turned out, we have a tendency to forget about luck.” — Michael Mauboussin

#4: The more you watch, the more drama you’ll experience

What makes March Madness so exciting is the drama of a 68-team, single-elimination tournament. Any team can win. There are teams that get hot at the right time, huge upsets, and typically a couple of buzzer-beating, game-winning shots.

Yet despite all of the drama, the actual winners of the tournament are fairly predictable.

Since 1985, teams ranked outside of the top 4 seeds only make it to the Final Four 5.5% of the time. While March Madness is known for its chaos and Cinderella-story teams, 95% of the time the champion comes from one of the teams ranked in the top 4.

If you wanted to avoid the drama and stress that comes from watching each and every game, you could simply pick your Final Four teams from the list of favorites and check back in at the end of the competition. Statistically, you’d have a good shot at winning your group and you wouldn’t have any idea of the twists and turns the tournament took to get to that point.

As a long-term investor, there will be many different economic environments, pandemics, wars, inflation, social unrest, political disruption, and a myriad of other events along the way as you try to build your wealth. The more you watch the stock market and the news, the more susceptible you become to making poor investment decisions out of fear. Good investors detach from daily fluctuations and focus on their long-term strategy.

“Money is like a bar of soap, the more you handle it the less you will have.” — Eugene Fama

Thanks for reading!