This week begins March Madness. Friends, families and co-workers have begun selecting their picks for the 2012 NCAA Basketball Tournament. As I contemplated my brackets, I realized that the selection process I was using to get to my winning team is similar to the process many people use when selecting investments.
First, there’s usually a hometown bias. This may be geographical or the team that is your alma mater. I attended both Indiana University and the University of Cincinnati. My attachment to these schools as well as my familiarity with their basketball programs typically leads to me advancing them farther in my tournament brackets than they often should go.
Next is the equivalent of Morningstar’s star ratings. Each team in the NCAA tournament is given a seed, ranking them in their region based on their past record and strength of opponents they’ve faced. If you have not followed basketball all year, it’s easy to fall into the pattern of picking teams with a higher seed because they seem more likely to succeed.
Many investors chose mutual funds that have outperformed their peers in the past because they have a higher star rating. Unfortunately, this does not guarantee the same results going forward. This is similar to the NCAA tournament. Not many people probably picked VCU to go to the Final Four last year or George Mason in 2006. Both teams were 11 seeds. In fact, I had to refresh my memory to what VCU stands for – Virginia Commonwealth University.