Emotions and Investing: Say Good-bye to the 0-2 teams
By: Joseph Thomas, CFA
As of the writing of this article we are two games into the NFL season and our darling Detroit Lions are 2-0. Expectations are starting to move up despite the fact we are just 12.5% of the way through the season. Thankfully we are off to a good start so no complaints on my end. What am I more interested in is the “phenomenon” of the teams that start 0-2. Since 2007, only nine percent of teams that have started 0-2 have made the playoffs, but each of the last four years a team that started 0-2 has made the playoffs. Even more hope for those 0-2 teams, is that the 2007 New York Giants started 0-2 and eventually won the Super Bowl.
As Lions fans, we are little concerned about this and have written off these 0-2 teams since the odds are slim. However, our Lions began the 2015 season with an 0-2 start. If you’re a fan who has not been too dejected over the years, in 2015 you’d be more open to this 9% chance of making the playoffs and likely could rationalize looking at the schedule, bad luck early on, injuries, etc. and say hope is not lost.
This is a common bias and can be found in many aspects of our life. It can rear its head into things like driving, two-thirds of people believe they are above average drivers. This obviously can’t be true from a statistical standpoint. People tend to view statistics as reasonable, unless it comes to something they have a personal stake in. At this point, like the 0-2 teams or driving, we find some reason to believe in the unlikely scenario.
In investing, this tends to be most identified as “anchoring or confirmation” bias. We get hooked on an idea or belief while continuing to ignore additional data that might not support that thesis. So instead of focusing on that 91% of the time that teams don’t make the playoffs we look at those few teams that made the playoffs and try to draw parallels. In investing, this can work on both the positive and negative side of things. A company or investment idea we like might not fit our criteria after further evaluation, but we put more weight into things that support our thesis that it is a good investment. Conversely, we can have the approach that while long-term market returns are X “this time is different” and we have entered uncharted territory.
When analyzing investment options, the more systematic and objective the approach the less likely you will stray into those statistically poor investments (all assuming the underlying model is sound). If we wanted to build a portfolio of playoff teams after two games, we’d eliminate all those 0-2 teams as its very unlikely they’d make the playoffs. Occasionally we’d be wrong, but we’d improve our odds of building a successful strategy by not focusing on those 0-2 teams. As you build your portfolio you’ll need a process to eliminate investments that do not fit your criteria, ideally these measures have been tested and proven over a long period of time. This should allow us to remain unemotional and avoid investing in things that objectively we wouldn’t normally invest in.
The Lions ended the 2015 season 7-9 (not bad considering they started the season 0-5). In an additional blog we can delve further into “anchoring” and how this one bad start to a season has overshadowed Jim Caldwell’s entire coaching record with the Lions (which is better than any other Lions coach to start their tenure with the team).
Investing involves risk, including the potential loss of principal.