My wife and I play in a fantasy football league comprised of a handful of other couples in and around our neighborhood. This season something interesting happened. As the start of our season drew near, one of the couples in the league had to back out. With literally a couple of weeks left before the start of the season we were in a pinch as nine couples had to decide on one other couple to join the league. Dicey, at best.
As the commissioner, I came up with a plan. Our 10th team would be a computer team. It would auto-draft and only play the players on its team that were projected to score the most points that week. Its drafted roster would be the only players on the team for the duration of the season. No trades, no adding new players due to injuries.
What you saw is what you got.
The concept was compelling and as the season went on, a couple of things jumped out at me:
Our computer team was the only team in our 10-team league to use the auto-draft process, meaning it would select the top rated player unless it needed to fill out the roster with additional players. More on this draft strategy in a minute.
Even though I didn't run the team, I was in charge of making sure the lineup was set and the top projected players were playing. Along the way, something interesting happened: I started to feel like it was actually my team. I was getting…emotional (gasp) about a team that wasn't even mine.
As I think about these observations, I can't help but find similarities to our financial lives when it comes to investing and investor behavior. So let's talk about my first observation.
In a league of 10 teams and 18 human beings, our computer team was the only team that didn't rely on human emotion, intuition, guesses or projections when it came to drafting its team. It did not allow hunches on this player or that player to sway its strategy. It simply drafted based on the ranking system and conducted a purely unemotional draft.
Hmmm, guesses, projections and hunches. When we look at how we invest, we can start to see some parallels. Investing is wrought with guesses, projections and hunches. See Gambler's Fallacy. Or think about a particular company or stock you thought for sure was going to go up/down and did the opposite. In fact, fantasy football is not all that dissimilar to trying to beat the market when it comes to investing:
We make predictions aka draft players we think (read: don't know) will outperform on a consistent and regular basis
We buy/sell based on past performance aka add or drop players to/from our roster depending on how they've performed previousl
We have no control over the rates of return meaning we literally are at the mercy of that player's game day status, the team's game plan, the weather, etc.
All of these uncontrollable factors can lead us to getting emotional and making decisions that may/may not work out. And then we second guess which could lead to more bad decisions. Yikes.
And then we also have to factor in market timing, which at its core is simply trying to determine if the market is going to go up or down, and betting I mean investing accordingly. In fantasy football terms, this would be the same as trying to determine your lineup and which players to play based on how you "think" they'll perform this week or next.
Our computer team avoided all of this.
Predictions and guesses: by automating the draft process (you KNOW I love me some automation) it had a plan and stuck to it even in the face of what some humans might fall prey to, temptation
Buy/Sell based on past performance: when we established that our computer team would not have this ability, it became purely a buy and hold team. This further enhanced our computer team's ability to avoid bad guesses and predictions. In your financial life, this would be akin to owning a basket of index funds that matches your stocks and bonds up with your ability to handle the market's ups and downs.
Market Timing: since our computer team could only play the players with the highest projected points for that week, it simplified the decision making process and again took emotion, guessing, and predicting off the table.
For the record, our computer team ended the regular season 10-3 which tied for best record. Remember everything we talked about above and then think about the success our computer team had doing as little as possible.
Apply as much of this to your investment plan as possible and then let’s talk about my second observation because…simple, not easy.
I'm semi-embarrassed to even be admitting this because I think it's silly. I mean, seriously. How could I become emotional about a team that wasn't even mine? Yet there I was following along with our computer team's score on Sunday's, rooting for this player or that player to "out-perform" based on the projection. I feel like I need an intervention or something…lol.
The reality is I'm human. I didn't draft the team, I had no part of it winning or losing, was not able to reap any of the awards our computer team may have earned this season. I simply managed the lineup. Yet I began to feel like it was my team. What in the pigskin was happening?
Well, what happened is this: I experienced Psychological Ownership. This can happen when we invest time and effort into something, have control over something, or even intimate knowledge of something. And since I was investing a limited amount of time into this team via making lineup changes, it happened to me.
**Side note: since our real team played the computer team in the playoffs, I was not sad when my…I mean our computer team lost.**
We all have psychological ownership when it comes to our investments. And whether you admit it or not, you will get emotional about your investments when they go down in the future and that’s because you're a human being and you experience emotions. And one of the negative outcomes of psychological ownership is a feeling of personal loss. So you will feel it, whether you like it or not and whether you admit it or not.
Interestingly, loss aversion can be one of the impacts of psychological ownership. Here’s an example of loss aversion:
When we're presented with the choice between small guaranteed gains over 5 years and a stock market linked product that carries a low risk of a large loss, we tend to focus on the large potential loss.
Why do we do this? In simple terms, it's because we have psychological ownership of our investments.
When we project this onto our financial lives, psychological ownership and loss aversion can have significant negative impacts. Our inability to manage our investor behavior due to psychological ownership and/or loss aversion (or other emotions and biases) can delay or even prevent us from reaching our financial goals.
Fortunately for me, I was dealing with psychological ownership issues that revolved around a fantasy football team. Yet, this low impact experience served as a good reminder for me to check my investor behavior around my own investments. Hey, I'm a human being, too.
At the end of the day, the difference between fantasy football and investing is quite simple. I've yet to see evidence that says over a long period of time you can expect to win more than you lose at fantasy football. Investing, on the other hand, is different. We know with a fairly good amount of certainty that, over a long period of time, a disciplined investor can expect to have more in his/her account in 20 years than he/she started with.
I'll admit our rates of return and portfolio performance can be tied to certain amount of luck when it comes to the sequence of returns we receive or experience over any given period of time.
The skill, however, is in acting like our computer team all along the way.