It’s hard to live in Chapel Hill and not be aware of the men’s basketball team this time of year-- especially when they continue playing into late March. After the team won their game this past Saturday, I saw the following statistic on one of the websites that allows fans to complete a tournament bracket:
Only 657 brackets out of 18.8 million correctly predicted the four teams that remain in the tournament.
No one at Woodward Financial Advisors has a bracket among the 657.
For readers who might not know how the college basketball tournament bracket game works, there are websites that allow you to select which teams you think will win each game in the tournament. A bracket must be filled out entirely prior to the tournament’s start. Consequently, if you have picked a team to win several games but they suffer an early loss in the tournament, then your bracket is “busted.”
Needless to say, it is challenging to accurately predict which teams will win and advance, particularly to the tournament’s final weekend.
That got me thinking about an alternative bracket picking contest. What if you had the option of picking a group of 12 teams to reach the Final Four, rather than picking the four specific teams? You could still win a cash prize (as is offered in many of these contests), but it would be smaller than the prize that you would receive if you correctly picked the specific Final Four teams.
Now you are faced with a trade-off. Accurately picking which 4 teams will make the Final Four is difficult and you run a greater risk of not receiving the prize, but if you are correct, the prize is large. Alternatively, the 12-team option increases the likelihood that your group will contain the four final participants, but the prize is smaller.
While this type of contest isn’t yet available to college basketball fans, investors face a similar choice every day. Some investors try to pick the individual securities or parts of the financial market that they think will be this year’s top winners. Others create a portfolio that includes a mix of investments that differ from one another in type (stocks vs. bond), size (small vs. large companies) and location (U.S. versus international). The latter approach is referred to as “diversification”, and it tends to serve investors well over the long term.
The table below, courtesy of Morningstar, shows the annual performance of various asset classes ordered highest to lowest by return going back to 1997. If you are unable find a pattern, other than the gray rectangles, then you are in excellent company. The overwhelming majority of professional money managers cannot consistently find a pattern that predicts future market returns either. Notice how the gray box, which represents a diversified portfolio, consistently appears in the middle.
Diversification, by design, means that a portfolio will not be at the very top of the performance ladder, but it avoids being at the bottom as well. In basketball terms, you might not win the championship in any given year, but you also won’t exit the tournament in the opening round.
Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. The diversified portfolio is equally weighted between small stocks, large stocks, long-term government bonds, Treasury bills, and international stocks (20% each). © Morningstar. All Rights Reserved.
At Woodward Financial Advisors, our brackets may be busted but we know how to build and maintain well diversified investment portfolios for our clients. If you have any questions about investment management or financial planning, please let us know.