Why we can’t predict winners consistently
It turns out our bracket-picking prowess gets clouded by many of the behavioral biases that derail investors. According to my friend Rory Henry @Roryshenry, business development director at Arrowroot Family Office and host of the AFO Wealth Management Forward podcast, here are the five most common biases that trip up bracket pickers and investors:
1. Recency Bias occurs when people give more weight to recent
events than historical data. For example, in the Big Ten Conference tournament
held just before March Madness, Wisconsin's surprising victory might lead many to
overrate them in the NCAA tournament despite a so-so regular season record. Conversely,
Purdue, who many saw as a top overall pick throughout the season stumbled in the
Big Ten Conference tournament and caused many bracketologists to remove them
from their Final Four selections. If you’re keeping score at home, Purdue cruised
through the first two rounds and Wisconsin was bounced in the first round.
2. Affinity Bias refers to our natural inclination to support
teams or schools with which we have a personal connection or fondness. As a proud
UCLA alum, Henry says he often picks the Bruins to win it all whenever they are
in the tournament even if they’re not having a great year.
3. Overconfidence Bias occurs when individuals overestimate
their knowledge or predictive abilities, which can lead to flawed
decision-making. Watching a lot of college basketball might make someone overly
confident in their bracket selections, possibly ignoring the unpredictable
nature of the tournament and the potential for upsets.
4. Confirmation Bias is the tendency to search for, interpret,
favor, and recall information in a way that confirms one’s preexisting beliefs.
In March Madness, if you believe a perennial favorite like Kentucky is a strong
contender, and all the pundits say so as well, you might ignore signs of
weakness (youth, inexperience, turnovers) that could be exposed against veteran
teams in the high-pressure NCAA tournament. No.3 Kentucky was sent home in
the first round by No.14 Oakland, a small commuter school outside of Detroit.
5. Intergroup Bias happens when we favor our own group (in-group
bias) and the negative evaluation of rival groups (out-group bias). For
example, Henry said if you have a strong dislike for a team like Arizona due to
its rivalry with UCLA, you might underrate Arizona's chances in the tournament,
not because of their skills or record, but because of the rivalry. Same goes
for Duke vs. Carolina, Michigan vs. Ohio State and Oregon vs. Washington. Henry
said: “You can bet your bottom dollar Arizona won't be making past the Round of
32 in my bracket,” but the Wildcats have posted two convincing victories so far
and are favored again in the Swett 16.
Then there are the intangibles like team chemistry and culture. As my friend Dan
McMahon, Managing Partner of Integrated
Growth Advisors (and a diehard UConn Huskies
fan) wrote
recently:
“While athleticism and recruiting budgets are important, the most successful
teams in the tourney year after year are those with strong cultures built on
trust, communication, and shared values. On these teams, every member of the
roster from the stars to the walk-on benchwarmers are valued and has a unique
role on the team.”
As I’ve learned over the years, filling out your
brackets is like constructing a diversified investment portfolio. You’re trying
to find the right balance between the “safe picks” (the top seeded,
blue-chip stocks) and the “upset picks” (the undervalue lower seeds, aka small
cap growth stocks) that earn you bonus points and separate you from the other
players in your pool. That’s where team culture, like a strong company
management and culture can trump financial statements and team stats.
Now, let’s look at how these
bracket-picking biases relate to investing:
Recency Bias. Investors believe that last year’s top
performing stocks and funds will repeat their success in the current year. In
reality, last year’s top performers are usually in the middle or bottom third
of the pack the following year. Remember how well tech stocks did in 2022 or
how poorly energy did? What a difference a year makes. Same goes for all the
bracket pickers going for last year’s Final Four participants San Diego State,
Connecticut, Miami and Florida Atlantic. Only UConn and San Diego State remain
this year. Miam and Florida Atlantic didn’t even qualify.
Familiarity Bias. It’s amazing how many people pick their alma mater to
do well regardless of the team’s record or who else is in its bracket. People
also tend to overweight teams that are in their geographic area because they
hear about them all the time on the news, or because many family members are
alums. The same goes for investors who overweight their portfolios based on the
industry in which they work, or Fortune 500 companies located nearby.
The reciprocal of Familiarity
Bias is Unfamiliarity
Bias. That’s the tendency to ignore promising investments
because you’re not familiar with the company or industry – or ignoring promising
overseas markets because you’re not familiar with the language or the culture. Same
goes for March Madness. West Coast hoops fans are far more likely to overlook East
Coast powerhouses like UConn, North Carolina and Marquette, even though both
programs have been in the national top 10 and make it to the Big Dance almost
every year.
Overconfidence Bias is another derailer for both investors and
bracket players. Most pool participants have massive confidence in top-ranked
teams. Yet, only once in the history of the tournament (2008) have all four
No.1 seeds made it to the Final Four. Some years only one of the four No.1
seeds will make it that far—you never know which one. Same goes for investors
who overweight the Magnificent Seven or Dow 30 stocks.
Following the Herd. Oddsmakers love it when the American public
stampedes over itself crowding into the same bets. History shows all four No.1
seeds almost never make it to the Final Four in the same year, but once again,
those top four rated teams have the most votes to make it to the Final Four
this year. And two of those teams (Houston and Purdue) have never won a
national title despite years of success. Reminds me of all the investors who continue piling into Nvidia, Amazon,
Tesla (and Bitcoin) despite their frothy valuations.
The “Halo Effect” comes into play when investors blindly follow
the recommendations or investing choices of gurus such as Bill Gross and Warren
Buffet. It’s the same when bracket pickers blindly follow the wonky statistical
models of KenPom, 538, and RPI, or blindly pencil in the “sleeper” picks of TV
analysts Kenny Smith and Charles Barkley, or former President Obama. As with
the stock jockeys on TV, the picks of the expert hoop heads on TV rarely pan
out.
Then there’s the fallacy
of “breakeven,” a
mental accounting trap that has plagued gamblers and investors alike for
centuries. How many times have you held on to a losing stock for years, just
waiting for it to get back to the original purchase price before you dump it? Likewise,
how many people keep selecting BYU (31 tournament appearances without a title);
Tennessee (26 appearances without a title); Alabama and Creighton (25
appearances without a title) to go far in the tourney because they have great
records again and this time, you tell yourself, it’s finally their year. Or
maybe, you tell yourself, it’s the Zags’ year because they’re long overdue for
a championship.
Gonzaga University, formerly a little-known “microcap” from eastern Washington is
now a mighty mega-cap in the world of college basketball. The Bulldogs have
qualified for the NCAA tournament an amazing 25 straight years and have never come
close to having a losing season during that span. They have an impressive
record again this year. The majority of bracket pickers have the Zags brand penciled
in for another deep run in the tournament – because they always do -- despite the
fact that Gonzaga has never won the championship. EVER.
Conclusion
Whether investing, gambling,
or taking part in the friendly office pool, always check your emotions at the
door. Working with an objective, independent advisor is one of the best ways we
know to prevent your intuitions from causing you to stray from your plan and
making costly turnovers that will shake your confidence and derail your plan.
Who’s your pick to win it all
and why? I’d love to
hear from you and why.
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