Nothing is Certain in Investing – Lessons Learned From the NBA Finals
Trying to predict the outcome of the NBA finals is like trying to time the market – you might win, but you might end up getting it very, very wrong.
Vegas priced the Warriors as the heavy favorite to win the 2019 NBA finals with the odds at -285 for the Warriors and +230 for the Raptors, meaning if you wanted to win $100 by betting on the Warriors, you would have to risk $285.
But imagine you had the option to just pick who you thought would win with 50/50 odds. The Warriors would be the no-brainer pick! No professional bettor in their right mind would not take the Warriors at 50/50 odds to win the series given their record and the depth of talent on their bench. But, like with the markets, nothing is certain, and trying to predict outcomes is a fool’s errand. Even the most elite professional sports bettors only have a win percentage slightly above 50%. What’s more, there are costs associated with gambling and active investing, so even a win percentage of 50% is not breakeven. You have to pay a percentage to the bookmaker, just like you pay to invest in the markets. This is just one more headwind to overcome when trying to come out on top.
So, what lessons about money can we learn from the surprising result of the 2019 NBA finals? Here are three things that the Warriors vs. Raptors series can teach us about investing:
1. “Experts” who try to predict the outcome of a game are often wrong.
Pollsters and experts were largely of the opinion that the Warriors would easily win the series – after all, how could they not? Statistically, it was a slam dunk. But the trouble with predicting what will happen in a basketball game is that you’d need a crystal ball to know for sure. It’s the same with the markets – experts will make claims that a certain sector will outperform, or that a bear market is on the horizon. But as with sports betting, the trouble with market timing is that in order to come out ahead, you must make the right calls consistently, and the odds are heavily weighted against you the longer you play.
Let’s say you do end up correctly guessing when to sell before a market correction. You’re still only halfway there because you now have to figure out if and when to get back in. That means you have to be right twice to make money. Here’s where emotions tend to play a role in market timing – when you get a call right once, it can lead to overconfidence in your ability to make predictions. Often investors (and sports bettors) become convinced that they will continue to be right, which means they ultimately lose money off that initial “right” call. Like with sports betting, success can sometimes blind us and lead us to make poor decisions.
The bottom line is that no one can predict with certainty what will happen in the markets (and basketball games) so it’s best to maintain your long-term approach and not make any knee-jerk reactions based on “expert” commentary or recent market movements.
2. What’s up today can be down tomorrow.
The Warriors were on an undeniable “roll” coming into this series. They’ve won 3 of the last 4 NBA championships, they have some of the best players in the league on their bench, and their record for this season was formidable. But as we saw, just because they had a great track record didn’t guarantee success in the finals this year.
The same goes for the “stock du jour” in the markets – people tend to be very heavily concentrated in certain sectors, like tech, since they are so enamored of their recent performance. But, as with basketball teams – past performance does not guarantee future success. Last year, tech stocks took a beating in the fourth quarter, dropping in spectacular fashion, and since then, we’ve seen some volatility amongst the gains in tech.
Obviously, tech and other growth stocks, have had a great run over the last few years. As have the Warriors! It’s only natural that many investors have become captivated by the higher numbers posted by the tech-driven growth.
But should you go heavy into tech and growth stocks because of the recent performance? Or should you lean into the conventional wisdom that value stocks tend to outperform growth stocks? This has been the longest period in history of growth outperforming value. What’s an investor to do?
One can go with what is hot – after all it “feels” like companies like Amazon and Apple can only keep getting bigger. Or, one can stay the course with their long-term investing strategy.
Our approach would be to stay balanced and invested in your long-term strategy. We usually advocate a relatively equal weight in both value and growth stocks, with periodic rebalancing. After all, what’s up today might not be in the future. Just look at the Warriors!
3. If the best player is injured, the whole team struggles.
With some of the best players on the Warrior’s squad sidelined during the finals, the team struggled to compensate and play to their normal standard. There were still some all-stars like Steph Curry putting forth a valiant effort to stay on top, but without players like Klay Thompson and Kevin Durant, the team was not able to overcome the ever-mounting uncontrollable variables working against them.
There are always random variables like injuries, referee calls, and human error that are uncertainties not fully priced into a game but can ultimately determine the outcome. The same is true for investing, where there are outside forces that can strike at any time and the more you make active bets, the more susceptible you are to these uncertainties derailing your portfolio.
Hence, the importance of portfolio diversification – if an investor relies too much on any one asset class (or “star player”), then they run a greater chance of something going wrong if one of their “players” gets “injured”. The basic principle of portfolio diversification is to ensure that your portfolio consists of a variety of asset classes across a variety of sectors so that you maximize potential returns while minimizing the risk that a big “injury” might be the downfall of the entire team.
To wildly oversimplify: a well-diversified portfolio is less risky and volatile than being heavily weighted in one area. Make sure your portfolio has a deep and diverse player roster.
To learn more about proper portfolio diversification, click here.