Don't Base Your Investment Success on Predictions

By Tyler Reeves, CFP®

During the first outbreak of spring storms in 2017, James Spann, along with most other weathermen in the Southeast, perfectly forecasted the day’s weather.

There would be, he said, unseasonably warm sunny skies throughout the early afternoon, followed by an outbreak of scattered, severe thunderstorms, with the occasional tornado touching down.

As the early afternoon sun gave the illusion of a beautiful day, armchair weathermen across the state began to murmur, “Well, I guess they missed it again,” and, “Those weathermen don’t know any more than I do.”

These are level-headed southerners who have experience with unpredictable, and often deadly, spring storms. I won’t even mention those who regularly spew their ignorance at Spann on Twitter and Facebook.

So, why the premature criticism?

Meteorologists, scientists, economists and even financial planners have all been tasked with making assumptions about the future based on yesterday's and today's information. They have also inevitably been criticized and written off as being wrong in situations where their predictions actually ended up being correct.

What can we do to avoid this inclination to play armchair predictor? Why do we feel the rush to judge at the slightest hint of an incorrect forecast? We'll look at this dilemma from a financial planning perspective since I've now exhausted all my knowledge of meteorology.

Understand the Investing Game

As a financial planner, one of the questions that I'm frequently asked is "What's the market going to do?" For years, I responded to this question with information from CNBC or The Wall Street Journal about recent economic data and trends. My answers, though sometimes long and eloquent, were mostly rooted in insecurity about what my job actually was. Now my answer is simple. "I don't know, but I'm planning on it going up over the next 30 years."

Good financial planners don't pick stocks. They use broadly diversified portfolios that are aligned to each client's risk tolerance and risk capacity. If your financial advisor has an opinion on which way the market is headed during the next week, month, or quarter, I highly suggest a brisk jog right out of the meeting.

"Our favorite holding period is forever." – Warren Buffett

Investing for the long-term is boring. No one wants to talk about index funds, expense ratios or efficient markets at a cocktail party. It's way more fun to speculate on Amazon's latest quarter or a recent presidential tweet that caused a 2% dip.

But if you're a serious long-term investor, that's not the game you should be playing. Returns this quarter, or even this year for most investors, are more noise than signal. For the same reasons that you don't search your neighborhood's home prices on Zillow every day, you probably shouldn't be tracking your IRAs and 401(k) day-by-day, or even month-by-month.

Know your investing timeframe. Understand that your portfolio is (hopefully) carefully constructed with that timeframe and your risk tolerance in mind. More importantly, constantly remind yourself of these two things every time you're lured into the trap of discussing "what the market did today." (For more from this author, see: Don't Let Social Media Affect Your Financial Plan.)

Know That Bad Things Happen

Bear markets. Recessions. Housing crises. International political chaos. Terrorist attacks. All these things have happened in the last decade and they'll probably happen again during the next. They are scary and hard to stomach as an investor.

Unfortunately, they are also impossible to predict with any semblance of accuracy.

There's no doubt that black swan events have and will continue to shape the history of the world. They are also incredibly rare, and by definition, can't be predicted. Perhaps an even greater risk, over the long-term, is our own inclination to use recency bias to confuse normal economic movement with the most recent catastrophe.

"People tend to assess the relative importance of issues by the ease with which they are retrieved from memory—and this is largely determined by the extent of coverage in the media." – Daniel Kahneman

By knowing in advance that these climactic events will occur (and markets will react negatively), hopefully we are able to curb the impulse to blame ourselves and others for "missing it."

If, in fact, you do see a market speculator boasting about his accurate prediction of the most recent market swing, be sure to check out his entire portfolio of guesswork. Odds are, if he called this one correctly, there are countless misses leading up to the one make. (For related reading, see: Investing During Uncertainty.)

Get Educated, Not Blinded

There's never been an easier time to confirm our own opinions. Whether it's a political issue, diet fad or investment forecast, we have unbridled access to echo chambers of our beliefs. Forming any investment decision on political ideology, ego or conversations with a neighbor can yield catastrophic results.

When asked about studying finance, Morgan Housel once said "The more you learn, the more you realize how little you know." As with many complex subjects, this is so true and should be a warning to anyone getting their finance education through CNBC or Fox Business. Unfortunately, the pragmatic approach of advocates for the globally diversified retirement investor doesn't boost ratings, so they don't see much airtime.

So, how can we become educated, but not blinded? Read more books and fewer articles. Turn off the TV and listen to more podcasts. When you develop an opinion, seek out and voraciously research the other side. Learn more about the psychology of decision making and less about market forecasts. Ask more questions. Never forget that incentives matter and everyone has them. Lastly, change your mind when the facts say you should!

Having a knee-jerk reaction to an unexpected event is basic human nature. But by arming ourselves with the information that we need to make better decisions through life's ups and downs, we'll be exponentially more prepared to stay out of our own way when it comes to our financial plans.

(For more from this author, see: Improve Your Financial Life With These 5 Questions.)

This article was originally published on Investopedia.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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