By Kevin Burkle, CFP, Certified Student Loan Professional | Founder of HCP Wealth Planning
At the time of this writing, we are a little less than 9 hours away from the start of the 2020 NFL draft. I am a lifelong NFL fan and more specifically, a die hard Carolina Panthers fan. For me and many other fans I know, the NFL draft is one of the most exciting times of the year. This may seem a little sad to non football fans (and my wife would agree). But the reason is because the draft provides a (usually irrational) glimmer of hope for fans who think their team can somehow draft a key player or two, and then they will all of a sudden have a shot at the Super Bowl. Unfortunately, my team has been hit or miss when it comes to the success of their past draft classes. So I started doing some research on the most successful NFL teams in the past decade, to see if I could find any correlation between their drafting strategy, and their win loss record.
This may not surprise hard core fans, but there does appear to be a connection between teams who trade down in the draft to stockpile a higher quantity of picks, and their long term success. Looking back at the 2010 NFL draft through the 2019 Draft, two of the three teams who traded down to stockpile picks more than any other team were the New England Patriots and the Seattle Seahawks. No matter how you personally feel about these teams, it is undeniable that over the past 10 years, they represent the best the AFC and NFC has to offer when it comes to consistently winning. The Patriots traded down a total of 22 times during this time frame and next in line was the Seahawks at 17. (Full Disclosure: The Vikings actually traded down the most at 24 times and while they weren't on the same level as the Seahawks or Patriots over the past 10 years, they had the 12 most wins during that time frame and probably would have won a lot more if Teddy Bridgewater never destroyed his leg. No matter how good the rest of your team is, it's hard o win when you have to start guys like Christian Ponder, Josh Freeman and Matt Cassel. Yikes!)
So why is stockpiling draft picks helping these teams be more consistently successful? It's all about managing risk. These teams are smart enough to know that the NFL draft is not an exact process. No matter how much college game film is watched, no matter how many physical and mental tests you put a prospect through at the draft combine, there is no such thing as a sure fire draft pick. Peyton Manning is the closest I've seen in the past 15 years and even he had a shaky rookie season. Injuries and a multitude of other reasons can cause a player to vastly under perform their draft status. So rather than trade up and put all their eggs in one basket the smarter teams would rather trade down and get more picks to give themselves more exposure to different players. The idea is that the lager quantity gives them a better chance of hitting on a franchise changing draft pick.
So what does the NFL draft have to do with investing? Successful long term investing involves the same principals of diversification and managing risk. Just like the NFL draft isn't an exact process, nobody can consistently pick individual stock winners over the long run (though plenty of shady "advisors" will try to convince you otherwise and take your money). By spreading out your portfolio across different types of investments, if one of them under performs at a given time, there is a decent chance that under performance will be balanced out by one of your investments that outperforms expectations during that same time frame.
The Seattle Seahawks had 3 extra draft picks in the 2012. This allowed them to take a chance on Russel Wilson in the third round. Look how that worked out for them. Wilson was considered to be a risky pick because of his size but the Seahawks mitigated the risk of him under performing expectations by having additional picks in that draft that could potentially outperform. What happens if you put your entire IRA balance in a single "can't miss" stock that vastly under performs? This would be like trading up in the draft to select a Ryan Leaf or Jamarcus Russel (If you are too young to know who these guys are then you can google them). Trust me when I say you don't want a "Ryan Leaf" to be the only thing in your portfolio if you ever plan to retire. These guys were supposed to be "can't miss" prospects that totally flopped. What you should be doing is selecting a basket of investments that all react differently to various market conditions and play different roles in your portfolio. So how should you go about doing this?
- Goals: Before you can decide HOW you should invest your money, you first need to decide WHY you are investing your money. An investment plan that is tied to a long term goal such as saving for retirement decades down the road will need to look a lot different than a short term goal such as saving for a down payment on a house that you want to be able to purchase in 2 or 3 years. Generally, the longer the time frame you have to reach your investing goal, and the more money you need to pay for that goal, the more aggressive i.e. more risky your portfolio needs to be. The shorter the time frame, and the less amount of money you need for your goal, the more conservative, i.e. less risky your portfolio needs to be.
- Asset Allocation: So what makes a portfolio more or less risky? It's asset allocation. The term asset allocation describes what percentages of your portfolio are allocated to the three main investment categories: Stocks, Bonds, and Cash (also referred to as short term investments). Generally, over time stocks have higher risk so they generate higher returns. Bonds have less risk so they generate lower returns than stocks. Cash or cash equivalents have the least amount of risk so they generate the least amount of return. As mentioned previously, a longer term goal should be assigned a portfolio allocation that has a higher percentage of stocks and a shorter term goal should have a portfolio allocation that has a higher percentage of bonds and cash.
- Investments: Once you have determined what percentages of your portfolio should be in the stocks, bonds, and cash categories, you then need to decide which individual investments you want to purchase in order to create a portfolio that has the desired mix. There are multiple ways to invest in stocks, bonds and cash, with mutual funds and exchange traded funds (ETF's) being two of the most popular ones. Mutual funds and ETF's allow you to purchase a basket of stocks or bonds all at once instead of having to go out and purchase them individually. This allows you to diversify your investments in a more simplified manner. When it comes to investment selection, we believe in focusing on what you can control. You have no real control over the future returns of your individual investments, but you can control how much you are paying for them. For this reason, whenever possible, we suggest using low cost, ETF's. In your employer-sponsored retirement accounts, ETF's are generally not available so try to focus on using low cost mutual funds when available.
- Stay Disciplined: Once you have implemented your portfolio with the asset mix and investments that align with your goals, the next step is the most challenging... Don't make emotional decisions to change the asset allocation of your portfolio unless your goals or situation has changed. For most people, this is easier said than done. Now, more than ever this is the most important part of the investing process. While the Covid-19 crisis has yet to play out, and every bear market is different, we are confident that in the long run, markets will recover. Take a look at the chart below which shows returns of the S&P 500 over the course of multiple negative political and economic events between 1999 and 2018. With each event, the media made it sound like the world was crashing down, but look how the markets performed over the long run.
- Rebalancing: If your goals or situation haven't changed, the only time you should make changes to your investments in your portfolio is when market fluctuations have steered your original intended asset allocation (and therefore your portfolio risk) off target. Rebalancing involves selling investments that have jumped in value and using the proceeds to buy investments that have not done as well. This may sound counter intuitive, but this actually helps you to buy low and sell high (good for returns) while keeping your original desired mix of stocks, bonds, and cash. Rebalancing allows you to take more of a methodical and scientific approach to investing rather than relying on emotions to make decisions.
- All investing involves some types of risk. The key to long term success is to focus on what you can control. This includes your investments costs and your asset allocation.
- The number one obstacle when it comes to achieving your investment goals, is not political or economic events, its you.
- Keeping your emotions in check and approaching your investment decisions methodically will lead to long term success.
- At HCP Wealth Planning, we recognize this is easier said than done. The best way to do this is to always fall back to your financial plan.
- When you determine what portfolios make the most sense for you and how they should tie into your overall plan, you need to factor in the various potential market incomes, including poor markets.
- If the markets are causing you stress you should revisit your overall plan and make sure nothing about your situation has changed that would cause you to want to reconsider the amount of risk in your investments.