Picking Your Investments Is a Lot Like the NFL Draft
The 2023 NFL Draft is just days away and it’s taking place in Kansas City, MO for the first, and quite possibly the only, time in history. Kansas City is home to a rich football tradition, and the best fans in all of the NFL, not to mention the best team in the NFL (Super Bowl Champion Kansas City Chiefs). It’s about time the NFL receives the Kansas City experience, and it all happens in the heart of Kansas City with the iconic backdrop of Union Station and the WWI Liberty Memorial.
A Brief History of the NFL Draft
Until more recently, the NFL Draft was held for several years at Radio City Music Hall in New York City from 1965-2014. It was where boys, growing up like myself, dreamed of hearing their name called and walking across the stage to put on their favorite teams’ hat, and share in the experience with the NFL Commissioner, of holding up your teams jersey, with your name on the back, announcing you as the number one overall draft pick.
For me, it was being drafted to play quarterback for the Kansas City Chiefs after spending four years as a Kansas State Wildcat all the while taking them to four straight national championships, and winning four consecutive Heisman trophies. Hey, a kid can dream!
Now, for 259 men, that boyhood dream is going to become a reality this week. Sure, only one will be the first overall pick and only a handful will be drafted to play quarterback for their team, but all are going to be able to say they were drafted by an NFL team. It’s years of hard work, determination, and discipline. It’s a lot like investing and saving for retirement.
Similarities Between the NFL Draft and Picking Your Investments
Everyone knows they need to be saving for retirement, and many know they need to invest that money to grow it for retirement, but fewer know what they should invest that money in to grow it for retirement. You’ll hear buzzwords like: “diversification”, “asset allocation”, “equities”, “bonds”, “market cap”... and so. I get it, it’s overwhelming.
As I talk with clients, prospects, and friends, I’m always looking for a better way to describe the investment piece of the financial plan to make it make sense.
As we prepare for the NFL Draft this year, I realized… the NFL Draft is a lot like picking the investments in your investment portfolio (or retirement accounts).
I’ve tried this in the past when I wrote a blog on the 4 Ways Investing for Retirement is a lot like Fantasy Football, so you’re probably starting to see a theme here. However, that was before I started a podcast and I have a few more years under my belt. So without further ado, here is how the NFL Draft is a lot like picking your investments.
Rule #1: Past Performance Is No Guarantee of Future Success
For every Peyton Manning, there is a Ryan Leaf. Both performed well in college, but Leaf’s professional career never panned out and is viewed by many as the biggest Draft Bust in History. Peyton Manning on the other hand had a hall-of-fame career paired with two Super Bowl trophies and is arguably one of the top 5 best quarterbacks of all time (and #1 most entertaining with his witty, dad-like humor).
The same is true for your investments. Just because something performed the best last year, doesn’t mean it’ll be the best performer this year. Heck, just because something performed well last year, doesn’t mean it’ll perform well this year.
This is best highlighted by the Asset Class Returns chart where you can see the performance from one year to the next for different asset classes.
While returns will vary from one year to the next, we can look at the historical performance of the market and its upward trajectory (see graph below). I’ve been coined, maybe by myself, as a pessimistic optimist. If you’re like me and believe in the resilience and innovation of U.S. economy, I believe that trend will continue in the long term, but there will be some bumps and bruises along the way.
Source: macrotrends.net
Just like scouts spend countless hours analyzing film and stats in an attempt to determine who is going to be the next Patrick Mahomes, investment professionals are trying to find the winning pieces to their portfolios for their clients. You can analyze investments based on their past performance, expense ratios, alpha, beta, sharp ratios, and many other factors, but there is no guarantee of future results.
Unfortunately, no one has a crystal ball to predict what the market is going to do in the short term and the long term. Advisors and those in the financial industry have assumptions and make predictions but there is no guarantee from one year to the next, that’s why a diversified approach is highly advised.
Rule #2: You Don’t Pick Just One Position, You’re Building a Team
While the first-round draft picks get all the attention, there are seven rounds to the draft. Teams are picking for more than just one position, they’re trying to improve their entire roster and fill in different positions where there are weaknesses.
Love him or hate him, Tom Brady was selected in the sixth round and is widely viewed as the greatest of all time (the Goat). The Patriot's first pick that year was offensive guard Adrian Klemm in the second round. I know, you’re thinking to yourself, “Who?”
With investments it’s similar, you don’t want to put all your eggs in one basket, you want to spread your money around in case a particular investment doesn’t pan out. Doing so spreads your risk around, and helps smooth out the swings up and down so it’s less of a roller coaster ride and more like riding in an elevator.
While one is a thrill ride that’s not made for everyone, the latter tends to be more calming, smooth, and boring. However that’s not always the case, and unexpected things do happen.
I recall times of hopping on an elevator expecting it to go up to my room floor, but it unexpectedly went down to the lobby before heading back up. I didn’t panic, and you shouldn’t either when the market is going through mood swings. It may mean you just need to find your balance.
Rule #3: Rebalance your Roster
You could view the draft as a way for teams to rebalance their roster similar to how advisors will recommend rebalancing your portfolio.
For example, a team trades a big-name player because they have more pressing needs at another position and they get some draft picks out of the deal or they let a player go to free agency because that player has gotten too expensive to keep and doesn’t fit with their plans going forward.
Those big-name players are commanding a big payday from teams competing for their services whereas the rookie players drafted to fill their shoes will be on a much lower-paying rookie contract. This is the old saying “Buy low, sell high” which is what rebalancing is.
When our portfolio gets out of whack from our original targets, we rebalance where we trim from our winners, and add to our losers to get back to our original targets. The idea is that you're de-risking your portfolio by not allowing a particular investment in your portfolio to become an outsized portion of your portfolio. As you’ve seen from the Asset Returns Chart mentioned above, what’s down one year may outperform the next.
When is the right time to rebalance?
Typically for individuals, it’s recommended to rebalance your portfolio once a year or semi-annually. The problem with this is you could be rebalancing at the wrong time to realize the benefits of rebalancing. It could be too early or too late in the market cycle where an investment hasn’t taken off yet but will later after the rebalance, or already peaked and has already declined back towards the original target. This is best highlighted in this blog post on Kitce.com on Optimal Rebalancing.
Now, I’m not sure if the NFL has a system for this but for advisors, many of us (myself included), use tolerance bands or thresholds to trigger a rebalance.
For example, you may have a target allocation in your portfolio of 10% for XYZ mutual fund (or ETF). If we put a 20% tolerance band on XYZ mutual fund, that would give us a tolerance range of 8-12% for XYZ mutual fund. This would mean if our 10% allocation of XYZ mutual fund grew to be more than 12% of our portfolio, or declined to be less than 8% of our portfolio it would trigger a rebalance.
This can be challenging without the use of rebalancing software. Fortunately, many advisors have this technology at their disposal nowadays.
Quick(er) Takes on the Draft Being Like Investments
Equities (stocks) are like early-round picks. You’re hoping for big production from them to fuel the growth of your retirement portfolio. These are the exciting ones that’ll reel off a 95-yard touchdown on any given Sunday… or Monday, or Thursday, or even a Saturday in the last few weeks of the season. These are the guys that are going to throw for over fifty touchdowns in a season. They might have a down season in there, but on average throw thirty-five touchdowns in a season.
Fixed Income (Bonds) are like the mid to late-round picks. You’re looking for a contributor that provides stability.
Not every draft pick is going to pan out, but you don’t release them after a week of practice. You want to see what they can do. If you’re constantly turning over your investment roster to chase after the winners you’re going to be disappointed. Chasing winners is a losing strategy.
Growth-oriented investments are exciting like drafting a quarterback, running back, or wide receiver. Value-oriented investments are less exciting like drafting an offensive lineman or a defensive player. You need both.
After all this, you might still be wondering what is the right mix of players (investments) to draft for my investment portfolio. That’s a great question and there is no one right or wrong answer.
Typically you want to have some exposure to domestic and international markets, growth and value, large cap and small cap. For bonds, it’s a similar process. Figuring out what’s right for you at the end of the day is up to you.
That may mean taking the time to do the research, piecing things together, and building your portfolio yourself. It could mean going to a robo platform where they put you in one of their portfolios and rebalance your portfolio as needed. This is easier than DIY, but a less customizable experience. For those looking for a more customized experience, an advisor may be the right option for you.
Conclusion
As you can see, selecting your investments is a lot like the NFL Draft process. There are no guarantees with either, but with the proper analysis and due diligence we can put ourselves in the best position to win. With that said, not all strategies are going to be winning strategies every year so we need to spread our picks around to fill in our investment lineup. Sometimes we need to realize the success we’ve had and reinvest for the future.
Hopefully, I have you ready for the NFL Draft and your investment draft. While I don't think I can help the Chiefs with their draft (they've done a pretty good job with that lately), me and my friends at the Kansas City Financial Advisors Network are here to help if you're looking for advice on your investment draft.
We can help you understand what you’re investing in and why, and how it relates to your overall financial plan. Many of us even take the work off your plate by providing recommendations, and managing investments for clients that would rather have a professional do it for them. Best of luck this draft season and don’t hesitate to seek out some help. Even general managers of football teams have advisors.
