March has truly gone mad as the inimitable Warren Buffett has teamed up with Quicken Loans to produce perhaps one of the most brilliant marketing boondoggles and at the same time one of the most bogus prize offers ever devised. And it will almost certainly work beautifully with no one to claim the reward.
The NCAA basketball tournament — otherwise known as “March Madness” — is one of the most popular and lucrative sporting events of the year. Warren Buffett is offering a billion-dollar prize for anyone who can correctly choose the winner of every basketball game in the men’s tournament bracket of 68 teams.
So what is the chance of claiming this jackpot?
According to a March 6 article in USA Today, there is a one in 9.2 quintillion chance of picking a perfect bracket randomly. But not all of the game outcomes will be equally likely because in the early rounds the strongest and weakest teams are paired against each other. So even though there will be some upsets in Round 1, even someone who knows something about college hoops has only about a one in 128 billion chance of winning the billion dollars.¹ (For the record, the ESPN online bracket contest over the past 16 years, with more than 30 million entries, has had no perfect bracket ever. I admit I play every year. I am a junky.)
The odds of picking winners in the investment world via the mutual fund “tournament” are not much better than winning Buffett’s contest — practically speaking. Standard & Poor’s Indices Versus Active (SPIVA) Funds Scorecard sheds some light on how difficult it is for an active manager to outperform the benchmark. We’ll take a look at four asset classes to see how many funds outperformed their benchmark index over the previous year. (Investors should actually use somewhere between six and 12 asset classes in a properly diversified portfolio, including bonds. However, for our discussion, four easily makes the point).
Here are the numbers from the SPIVA study:
|
Percentage of Funds that Outperformed Their Benchmark |
|
|
Asset Class |
1 Year (%) |
|
US Large Cap |
40 |
|
US Large Cap Value |
28 |
|
US Small Cap Value |
29 |
|
International |
46 |
As you can see from the chart, a mere 40 percent of the active large
.40 x .28 x .29 x .46 = 1.49%
or 1:67
Investors had less than a 2 percent chance of finding money managers that could beat the market in each of the four asset classes. Keep in mind we are not supposing we have found the best fund — just one that has beaten its benchmark index for one year.
Now since one year does not an investment horizon make, what if we wanted to pick four funds that could beat the index five years in a row? Here it is (assuming the percentages from the June 30 SPIVA are proxies for future probabilities, the fund selection in each asset class is independent from one another and that the selection in one year is independent of the selection or results in a previous year):
Five Years: .0.010 x 0.002 x 0.002 x 0.021 = 0.000000745% or 1 in 1.3 billion
So would Buffett offer the same prize money for anyone who could beat these odds? Probably not. But just like basketball fans who will dive headlong into the futile March Madness contest, many investors believe they can “beat the market” by simply choosing the winners.
As a practical matter, it is unlikely that such speculative habits would mesh with the buy-and-hold posture that is needed to patiently wait out a fund manager’s poor years for even a five-year timeframe. Most investors would jump ship after one or two “bad” years thus annulling their “winning teams.” This all speaks once again to the time-honored investing wisdom of using passive, evidence-based strategies to provide the best opportunity of “winning” in the long run.
So have a little fun with the NCAA bracket this month. It won’t cost you anything. But when you take the same speculative chances like this with real money, the price you pay for losing can be the difference in a retirement where you watch the big game from your padded courtside chairs - or you squint through the rafters from the cheap seats.
Copyright © 2014, The BAM
"My name is Neal, and I'm a lane changer. It’s been two weeks since I changed lanes — and that’s only because it’s been two weeks since I was on the highway!”
If there were an organization similar to Alcoholics Anonymous for chronic lane changers, I would join. I know I have a problem, but I find it hard to stop. If I don’t change lanes, I feel like everyone’s passing me by. And that’s despite the fact that I know that research shows that lane changing doesn’t get you to your destination any faster, while it puts you at greater risk for having an accident.
One interesting thing that the research on lane changing revealed is that there are perceptual illusions that fool drivers into thinking they are in the slower-moving lane more than they really are. Even when two lanes are moving at the same average speed, it doesn’t seem that way to drivers.
There’s a parallel here to another kind of lane changing: active trading. (Thankfully, I have no problem avoiding this one.) Just as lane changing increases the risk of harm, constantly changing our investments can hurt performance and increase our trading costs and taxes. And as with driving, a "perceptual illusion" can make it seem as though active traders and actively managed funds are getting ahead of investors who follow an evidence-based approach. One cause for this illusion is that the media tend to report on which active managers did well over some (often short) period, or which segments of the market have been particularly kind to active managers lately (small caps one year, emerging markets the next). The same media spend much less time talking about the research that shows that evidence-based investing has consistently beaten active management after fees and expenses.
Of course, there are times when changing lanes makes sense (for example, to get off at an exit or go around a slow-moving truck). And there are times when changing investments makes sense — but only when your circumstances change, as with an inheritance or an unanticipated major expense.
When we find ourselves tempted by stories about the latest hot manager or sector, thinking that it’s time to switch our investments to a faster lane, it pays to keep our eyes on the road and remember that, when it comes to active management, this year’s speed demon might be next year’s slowpoke.
Copyright © 2014, The BAM ALLIANCE. This material and any opinions contained are derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. To be distributed only by a Registered Investment Advisor firm. Information regarding references to third-party sites: Referenced third-party sites are not under our control, and we are not responsible for the contents of any linked site or any link contained in a linked site, or any changes or updates to such sites. Any link provided to you is only as a convenience, and the inclusion of any link does not imply our endorsement of the site.
Abraham Lincoln first ran for the Illinois General Assembly in 1832. He lost. Subsequently, he lost a race for the House of Representatives and two races for the Senate. The love of his life died in 1835. He had a nervous breakdown in 1836. He campaigned for a vice-presidential nomination and lost. He persevered and, after a bruising battle for the Republican presidential nomination, was inaugurated as president on March 4, 1861.
Lincoln had grit.
The Importance of Grit
Angela Duckworth, an assistant professor of psychology at the University of Pennsylvania, led an extensive study featured in the Journal of Personality and Social Psychology that focused on the role of grit in success: “The gritty individual approaches achievement as a marathon; his or her advantage is stamina."
What is grit? In an American Public Media story, Duckworth defines grit as “sticking with things over the very long term until you master them."
How important is grit? Duckworth found that it might be every bit as important as intelligence. We all know very intelligent people who are not high achievers and people of lesser intelligence who are high achievers. What accounts for the anomaly? Grit.
Duckworth tested students at an Ivy League school. She found the more intelligent students had less grit than those who had lower scores on standard IQ tests. Yet the less intelligent students had higher GPA scores. Why? Because they worked harder and with more determination than their more intelligent peers.
Calculate Your Grit
There is a way to determine how much grit you have. The University of Pennsylvania has a test you can take online to determine your “grit score.” According to the study, the United States Military Academy at West Point found that a cadet’s grit score was a better predictor of success than intelligence, the ability to lead and fitness.
You Control Your Grit
Once you recognize the importance of grit and have determined your grit score, how can you become more gritty? Duckworth does not believe the amount of grit you have is fixed. It can change over time, just like other personality traits. She also notes that grit is not fixed across all activities. You can be very focused on some tasks but not on others. Children can be determined to improve their sports skills but easily frustrated trying to learn math.
If you are interested in a particular field or activity, you are more likely to persevere. Our goal should be to improve our “grittiness” for tasks we don’t enjoy.
Tips for Improving Your Grit
Featured in a 2013 Advisors Perspectives article, speaker and author Dan Richards offers these suggestions for improving your grit:
Choose how you react to adversity (like the loss of a major customer): You can consider it a disaster or view it as an opportunity to go after new business so you will not be so dependent on any one client.
Temper your optimism: Unrealistic optimism leads to disappointment. You probably won’t triple your profits this year, but you could increase them by 20 percent. The key is to be realistically optimistic.
Pay attention to your body: A healthy diet and regular exercise are critical to your success. You can’t be focused on new business when you are recovering from a major illness. Put yourself first.
Challenge yourself: Confront your fears (like public speaking or approaching new customers). Richards cites studies that show that doing so leads to “stress inoculation,” giving you increased capacity to take on new challenges.
Network: We all have highs and lows. Especially during those low periods, when our grit lags, we need the help and support of people we respect, who care about us.
Have role models: It doesn’t matter if your role model is Lincoln or your neighbor. Having role models who have overcome challenges will give you the strength to confront your obstacles.
Grit Pays Off
Actor and musician Will Smith doesn’t attribute his success to intelligence or talent. He’s credited with saying, “I will not be outworked, period. You might have more talent than me, you might be smarter than me, you might be sexier than me, you might be all of those things — you got it on me in nine categories. But if we get on the treadmill together, there’s two things: You’re getting off first, or I’m going to die. It’s really that simple.”
The same, intense, single-minded focus and determination is what separates successful people from less successful ones.
Here’s the takeaway: If you want to achieve more success, it might not be your lack of intelligence or talent that’s holding you back. Try increasing your grit.
Copyright © 2014, The BAM ALLIANCE. This material and any opinions contained are derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. To be distributed only by a Registered Investment Advisor firm. Information regarding references to third-party sites: Referenced third-party sites are not under our control, and we are not responsible for the contents of any linked site or any link contained in a linked site, or any changes or updates to such sites. Any link provided to you is only as a convenience, and the inclusion of any link does not imply our endorsement of the site.