One of my passions over the years has been playing fantasy football. Now that we are full swing into football season, I recently had the revelation that a successful DraftKings strategy has similarities to a successful investment strategy. Now at this point you may be asking the question, “Is investing like gambling?”, but you’ll have to read on to find out the answer.
IT’S ALL ABOUT THE PROCESS
Now let me be the first one to say that I would not classify myself as a successful DraftKing’s player. Although I have been successful at traditional season long fantasy football (made the playoffs 71% of the time and have a total return of 134% over a 9 year period), I have not been as fortunate with DraftKings or any other daily fantasy sports (DFS) site for that matter. In fact, during my first 2 years of playing on DraftKings (2015 and 2016), my total return is -32%.
So, what gives me the authority to compare investing to DraftKings? Absolutely Nothing. It’s at this point that I will turn to the pros (this is a shout out to @chrisraybon and @tjhernandez at 4for4.com; these guys have some great content) and leverage their expertise for what makes a successful DraftKings player.
Even the pros in the DFS arena (again this would not be me) only win a little over 50% of the time. But it’s enough for them to be profitable. And to be profitable, they will tell you that you have to follow a consistent process week in and week out.
If you constantly change your process then you will likely not be successful. In DFS and investing, there
may will be times when the process doesn’t pay dividends for you, but you have to put yourself in a position (with a consistent process) to capture the returns when they come.
For example, in DFS, the research shows that there is a very high correlation to pairing a QB with a WR on the same team. In other words, if the QB does well then most likely the WR will also do well. This is called a QB/WR stack. And it tends to be a very profitable strategy. I looked up the winning lineups for the DraftKings Milly Maker contest over the past 2 years and a very large majority of them consisted of a QB/WR stack. Somewhere around 60% of the winning lineups employed this stack.
Therefore, if you deviate from that proven strategy, due to a recent trend or a different strategy that happened to work out for someone else, then you likely won’t be consistently putting yourself in a position to win.
So, how does a consistent process tie in to investing?
YOU MUST BE PRESENT TO WIN
Much is written in our industry about active management approaches that attempt to avoid market crashes or downturns. In other words, active managers spend a lot of energy and resources developing processes that are intended to tell investors when to get into and out of the market. It certainly sounds very appealing on the surface. After all, who wouldn’t want to get into the market just before it goes up and then get out just before it goes down. Sign me up for that – if it actually existed!! There is a tremendous amount of growing research that shows that making these types of predictions is usually futile and ultimately costs investors a lot of money and missed returns over time. In addition, the research shows that the vast majority of active managers have very low odds of success!
So, what’s the alternative?
Instead of trying to move into and out of the market, a better strategy (heavily grounded in Nobel Prize and academic research) is to remain in the market and position your investment portfolio in a way that captures areas of higher return historically. These areas of higher return aren’t always present, but can show up at any given time, so you have to be present to win.
If you are moving into and out of the market, then there is a high likelihood that you won’t be present to take advantage of the gains when they come. You’ll perhaps be on the sidelines watching. Take a look at this chart which shows how the majority of gains come in a very short period of time. It would be virtually impossible to predict those times. You must stay in the game!!
In other words, having a reliable, heavily researched, and consistent process will help position you for a successful investment experience.
DON’T CHASE PERFORMANCE
It should be evident by now that chasing performance is not a wise idea as that would be contrary to following a consistent process.
When playing DFS there is a concept known as recency bias. This can be either positive or negative. For example, if a player had a really good performance last week, then many people would be biased towards using that player this week. Or if a player had a really poor performance last week, there would be a tendency to fade (not play) that player this week.
Recency bias also exists in the investment world. For example if an investment did great in prior years then many people are biased towards owning that investment this year. This is a common way for how people choose investments in their 401k plan. Alternatively, if an investment has historically poor performance then people would tend to shy away from it. However, choosing investments based on past performance (recency bias) is not a reliable investment approach. In fact, data from Morningstar and the Center for Research in Security Prices from University of Chicago shows that most mutual funds in the top quartile (25%) of previous 5-year returns did not maintain a top quartile ranking. In other words chasing past performance provides very little insight into a mutual fund’s future returns.
While I may not be a successful DraftKings player, there are lessons we can learn from the pros that apply to investing. Following a consistent process (without deviation) while not chasing past performance can set you up to achieve the returns when they come. While we obviously do this with our clients, I’ve personally been implementing this in my DraftKings strategy for this year (2017). And although we are only two weeks into the NFL season, I am proud to say that I am up 44%. But of course this is just entertainment for me and certainly not what I would call an “investment strategy”!!!! Now if you’ll excuse me, I’ve got to go build some lineups before the contests are all full.
I hope that you have found this week’s blog post entertaining, informative, and helpful. Please feel free to share any comments, questions, or experiences you have below.
If you’re new to our blog and wish to receive weekly financial planning tips, please sign up for our eContent.