What Good Are Predictions?

Russell W. Hall, CFP®

Commonly asked questions that we as financial advisors hear all the time:

What will the Dow do this year?

            What hot stock I should buy right now?

            Where can I invest and earn big returns, without taking any risk?

If you haven’t figured it out by now, all of these questions center around predicting the future. But can this actually be done?

The 40% Rule

A few years ago the Wall Street Journal published a fantastic article about the common practice of experts forecasting the future, but hedging their bets by stating there was a 40% chance their prediction would come true. Our favorite part: “…you never have to say you were wrong”, because even if the estimate is way off base, the analyst can always say their prediction was just a “possibility” and had less than a 50% chance anyway! And if the pundit happens to get it right, they will look like a genius and be invited back for the next interview or roundtable.

But why are these forecasters and analysts still in demand, if they are consistently avoiding real predictions at best and often being completely wrong? For the same reason that expensive investment newsletters promising Five and a Half Hot Stock Tips Right Now or Seventeen Ways YOU Can Become Wealthy in a Month still draw subscribers. People want to know the future so they can plan for it (and make money), and especially in the investment world they think the experts have the answers.

Some Get it Wrong

The unfortunate truth is that no one can predict the future with certainty. Many pundits have seemed prescient when their forecast for a market collapse or a huge investment return came true (or seemed to), and several have built their careers around making one right call. But no one can be right all the time, and indeed all of the experts have been very, very wrong at one time or another. Here’s a few examples:

-       One expert predicted in 2011 that the Dow would crash to 3,000 in 2013.  Instead it ended at 16,577, up over 26% for the year.

-       Another famously saw the 1987 crash coming - but among many other incorrect predictions since that time, he said in 2014 that another huge crash would happen in the next 12 months. Instead stocks were up in 2014 and basically flat in 2015.

-       Back in 1999 a well-known analyst, enthusiastic about the dot com era, saw the Dow going to 100,000 by 2020. The index actually finished 2020 at less than a third of that value, even after a great return.

Crystal Ball

Some might argue that we are picking the most sensational prediction failures without mentioning the successes, and they wouldn’t be wrong! But the truth remains that no one, not even the most informed and careful expert, can tell you exactly what’s going to happen.

In my office I have a crystal ball. When clients ask one of the three questions from the beginning of this article or something similar, I gesture to it and say “Unfortunately, my crystal ball is broken right now.” People laugh, but they usually get the point.

I then try to direct the conversation to the types of the things that we can control and manage with some level of certainty.

            How much should I save for retirement?

            How much should I allocate to risky investments like stocks?

            What should I do when the stock market falls?

These questions should really be the most frequently asked, as they’re more concerned with investor behavior. Although answering them often involves making some realistic assumptions about the future based on past data, very little time is spent making predictions. It’s important to be aware of what we can and cannot know, and be clear about the difference between them.

What You Can Do

If you don’t get anything else out of this article, we hope you recognize that it is in our nature to want to know what the future holds. This desire can cause us to listen to predictions and even worry about them, many times to our detriment. Watch out for experts who confidently forecast the next big crash or the next big stock. Instead, focus on controlling what you can and keeping the mindset of a disciplined long-term investor.

If you’d like to know more, schedule a 15-minute discovery call with a fee-only financial advisor.