Credit: Shutterstock photoIt was early September and the fantasy football draft was about to begin. Last year’s performance was wiped away, and there was nothing stopping me from drafting a new team to win the coveted fantasy football championship. Four months later, the fantasy football regular season is over: looking back, it didn’t turn out exactly the way I had hoped. However, fantasy football taught me three very important lessons about how to invest: past results do not equal future success, diversification is key as an investor and behavioral biases can negatively impact your investment decisions.
Past Performance Doesn’t Guarantee Future Results
David Johnson came into the 2017 season widely rated as the number one fantasy football draft pick. In 2016 he rushed for 1,239 yards, caught 80 passes for 879 yards and scored a total of 20 touchdowns. He was poised to have an amazing 2017 season, and with the number one pick in my draft, I knew he was going to help me win the championship. Until he didn’t. He dislocated his wrist in the first game of the year and hasn’t played a game since. How can that be? With his incredible performance last year, it seemed certain he would perform well again in 2017!
The same thing can happen in investing. Remember BlackBerry? Formerly the most prominent phone company in the world? Going into 2007 BlackBerry was the hottest smartphone on the market. BlackBerry’s stock price rose from just over $60/share in June of 2006 to over $140/share just 13 months later. BlackBerry was the David Johnson of the phone market. It was on a tear until a little thing called the iPhone came along.
Currently, BlackBerry's stock is trading around $10/share, and has nowhere near the market share of its competitors. But it’s not just BlackBerry that suffered this fate.
JC Penny, Chesapeake Energy, Enron, Kodak. These are all companies that were once giants in their industries. For one reason or another, none of these companies enjoy the same dominance that they once had. Whether it’s fantasy football or owning stock – David Johnson or BlackBerry smartphones – past results are no guarantee of future performance. (For related reading, see: Misconceptions About Past Performance and Future Returns.)
Diversify as an Investor
My strategy going into the season was flawless. I was going to draft a running back with my first draft pick and then my next two picks were going to be wide receivers. In my 14-person league, that meant drafting David Johnson, DeAndre Hopkins and Keenan Allen. A solid first three draft picks, I thought. But the wide receiver selection didn’t stop there. I went on to select Jarvis Landry and Danny Amendola with two of my next few draft picks.
Nothing is wrong with these receivers. But here’s the thing: I didn’t draft any other high-quality running back besides David Johnson. And I had to learn lesson number one the hard way, by losing Johnson in the first week of the season! So what happened? I wasn’t diversified. I owned too many wide receivers and not enough running backs. So when my only strong running back went down via injury, I didn’t have a viable running back to capture the points I needed for that position. What happens when you’re not diversified as an investor? You also suffer.
If you started investing in 2000 and you only held big U.S. investments, you would have actually lost money over the next 10 years. The S&P 500 index was at 1,469.25 on January 1, 2000, and it dropped to 1,115.10 by December 31, 2009. Now, this doesn’t account for the impact of dividends over this time, but it does show us the danger of not being diversified.
If on the other hand, you also owned international investments, small companies or bonds between 2000 and 2009, then your performance would have been higher (assuming of course that you held your investments the whole time). While U.S. stocks struggled mightily between 2000 and 2010, international stocks, emerging market stocks, small company stocks and bonds all fared much better.1Going into the last decade without being diversified was like me going into my fantasy football season without any good running backs. Don’t make the same mistake I did! (For related reading, see: Introduction to Investment Diversification.)
Don't Let Behavioral Biases Impact Your Investments
In my second fantasy football league, I used my fifth-round pick to draft Danny Woodhead. Like David Johnson, Danny Woodhead was injured during the first week of the season. He was set to miss at least the next eight weeks of the 13-week fantasy football season. And with roster spots being a precious commodity, it was tough to decide whether or not I should keep him. So what did I do? I kept him. The end result: Woodhead sat on my bench for the next 10 weeks, taking up a spot that could have been filled by a player who would have contributed to my performance. Was this a good decision? No. Did I do it for rational reasons? I hate to admit it, but no.
I did it for two reasons. Reason number one: Woodhead played for the Chargers for four years. He was loyal to my Chargers, so of course I had to show loyalty to him. How could I cut a player who was so close to the team I cheer for? Reason number two: I chose him. He wasn’t given to my fantasy football team. He wasn’t chosen by someone else. I chose him. There are a lot of parallels that can be drawn to behavior people commonly show with their investments. (For related reading, see: Understanding Investor Behavior.)
I’ve met with many people who own their own company’s stock. There’s nothing inherently wrong with this, but the loyalty they have for their company can hinder their ability to make rational investment decisions. I have seen many cases when selling company stock was the most rational thing to do, but many of these people’s loyalty to their company prevented them emotionally from being able to sell it. I know the feeling! The loyalty that kept me from cutting Danny Woodhead is the same as the loyalty people feel when it comes to selling their company’s stock.
Research shows us that when we choose something, it can automatically become over twice as valuable to us in our minds. This means we value something we own by choice over 100% higher than an uninvolved party would be willing to buy it for.
But that’s exactly why it can be so difficult to sell losing stocks. We know the stock is dead in the water. We know it’s probably not a good idea to keep it. But we do it anyway. Why? Because we were the ones that chose it. I chose Danny Woodhead, so I kept him even when prudence would have suggested a different strategy. The same behavioral biases that led to me keeping Danny Woodhead can also cause investors to keep investments that aren’t good for them.
Fantasy Football Helped Me Become a Better Investor
I ended the fantasy football season 3-10 (I’d like to think that I’m better at investing than I am in fantasy football). But if there’s any silver lining in my season it’s this: Hopefully the principles I learned about building a successful fantasy football team will help me to become a better investor. (For related reading, see: 10 Tips for the Successful Long-Term Investor.)
Source:
1. Dimensional Fund Advisors, Matrix Book 2017, Historical Returns Data- US Dollars
This article was originally published on Investopedia.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
