Investing In The Stock Market: March Madness Edition

by: Wall Street Survivor

We're into the sweet sixteen of March Madness - and already there have been some amazing moments. Whether it was Bronson Koenig's buzzer beater helping Wisconsin into the next stage of the tournament… or the thirty seconds of madness that saw Texas A&M overcome a 12 point deficit… this year's edition of March Madness has not disappointed.

While these incredible moments capture the imagination and excite the senses, any good coach will tell you that mastering the fundamentals and doing the basics - correctly - are the keys to winning basketball games. It's the same for investing in the stock market. You can't rely on the buzzer beaters and freak momentum changes in the state of the game to carry you forward - instead you have to rely on your game plan.

Your March Madness Investing Game Plan:

Defense, defense, defense

As the cliché goes: offense wins you games - but defense wins you championships. The saying holds true in investing as well, where it's more important to build wealth and accumulate gains steadily than risk it all. Many prominent investors like Ray Dalio or Warren Buffett will tell you that the first thing they look to do is protect their downside, i.e. they seek to limit the amount of money they can lose.

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That's because even if you think your position is safe and your strategy is sound - the market can behave irrationally longer than your money can last. As Buffett says, the first rule of investing in the stock market is don't lose money. The second rule: don't lose money.

Once you figure that part out, then you can build on top of that foundation just as a playoff-winning team builds on the solid nature of its defense.

Don't get caught up

Emotion can cloud your judgment, as the Northern Iowa players probably found out against Texas A&M. It happens all the time, your team is on top and you're cruising and then all of a sudden - someone on the opposition catches hot hands. Bucket after bucket is drained and you can almost see the morale leaving your teammates. You get flustered… which leads to more mistakes… and before you know it, the game is lost.

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You can see where we're headed with this. You bought up a few shares of Exxon Mobil (NYSE:XOM) because you think oil prices are going to rebound. You've done your homework - you know that Exxon has enough money in the bank to weather any storms and once oil prices normalize, you know that their stock is going to double. But your assumption here is that oil will go up, and then it doesn't. It goes down, and it stays down.

That's when you need to keep your wits about you and leave emotion out of the equation. When you invest, you want to be able to make decisions free of emotion. The way to do that is to have rules for each and every investment you make. Ideally, you put a lot of thought into each investment before the money ever goes in and you try to imagine different scenarios. What's your best-case and worst-case scenario and what will you do in each situation?

For example, if one were investing in Exxon, they might set up a rule where if the stock price declines by 30%, then you'd hold steadfast. If it declines by 50% then you might sell half your holdings, and so on and so forth.

The only way this works is if you lay down your reasoning for each decision and reviewing them when they're triggered. For example, you may decide that if Exxon declines by 50% you'll do nothing because of reasons A, B, C. Always ask yourself, "has anything changed?" If nothing has happened that forces you to revaluate, then you carry on.

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Guidelines and rules are great because they remove the emotionality and associated stress out of the decision-making process. Future stressed-out you doesn't have to do the thinking because past rational you has done it already.

Be well-rounded

The best teams have players who are world-class in different areas of the game, be it dribbling, passing, shooting or defense. The best way to be a well-rounded player in the investment game is to diversify your holdings. Diversify into different asset classes so that your risk isn't concentrated in one area. Your ideal portfolio might include U.S. and emerging market equities as well as a solid government bond index funds. Throw in a smidge of commodities and you'd have a pretty standard diversified portfolio. How you mix and match will depend on your level of risk tolerance and your unique investment goals.

Ignore the noise

If you are an unfancied team looking for glory… you'd do well to ignore the noise. Everyone and their mother will tell you that you don't stand a chance, but what do they know?

Nobody knows anything. Predicting the future is impossible.

The experts pretend to know something but the teams picked to have a deep run in this year's tournament have already been knocked out. Expert forecasters at ESPN and fivethirtyeight have been proven wrong. If they can't do it right then why bother listening to them?

Just like a huge basketball tournament with many moving parts, investing takes place in a complex and dynamic system. First, you have to accept that you know nothing. Once that happens, you can begin to make more intelligent decisions regarding your capital.

You'll need to refine your sense of what is noise and what is the signal. When we say signal here, we refer to information that actually provides insight and nuance into your understanding of how the market actually works.

To do that? Pretend you're an unfancied basketball team at the NCAA tournament. Put your head down, get in the trenches and do the hard yards. Put enough effort out there and you might just get your team into the finals.