Financial Forecasting Is Meaningless. Learn How To Invest Profitably
- The critical difference between knowable and unknowable financial advice.
- How statistics prove you should never put capital at risk on a prediction.
- Investment strategy that works based on proven facts.
Americans pay millions every year to financial advisors, psychics, fortune tellers, forecasters, and assorted hucksters and gurus claiming to have some insight into the future.
The reason is because the essence of investing is putting capital at risk into an unknowable future so people seek financial forecasters in a desperate attempt to bring certainty to an unknowable future.
They want to believe these soothsayers have enough foreknowledge about financial events to make a meaningful difference.
Unfortunately, they don't, and the facts prove it.
I learned this painful lesson about financial market forecasting the hard way. It literally cost me a small fortune.
The good news is market losses have a mysterious way of helping people sort right from wrong.
You only need to touch the hot stove once to learn it's a bad idea, and investing based on financial forecasts is a bad idea.
That's why, if you walk into my office, you'll notice no financial media. No CNBC, no magazines, no newspapers, or other sources for news-of-the-day “financial porn”.
You might also notice my bookcases overstuffed with investment books and the hard drive on my computer filled with academic research papers.
That's because certain types of information help you improve your investing, and other types of information are edu-tainment (or financial porn). Understanding the difference between useful financial advice and useless market forecasting was a lesson hard learned.
Hopefully this article will help shorten your learning curve.
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What's The Secret To Sorting Good Advice From Useless Financial Forecasting?
The problem today is there's more information than anyone can consume, and much of it's junk.
You must pick and choose what financial advice you spend your limited time and attention on if you want to be financially successful.
But, how do you do that?
The first step is to become crystal clear about the difference between what's “knowable” and what's “unknowable” so that you can stop wasting valuable brain space on unknowable information.
Once you know the difference between unknowable and knowable information, you'll be amazed just how much can safely be ignored.
“Isn't it interesting that the same people who laugh at science fiction listen to weather forecasts and economists?”– Kelvin Throop
The reason unknowable information, such as financial forecasting, should be ignored is because it confuses your decision process. It appears credible, causing you to factor it into decisions, but it has no basis in fact.
It's fiction – a figment of the author’s imagination. Investment market forecasts are never a rational basis for an investment decision. Therefore, the only solution is to avoid unknowable information altogether so it doesn't muddle your thinking.
That's why I ignore CNBC and don't read most investment periodicals. Most of the information dispensed through these media channels is either unknowable or not usable.
The primary purpose of the content is to entertain because entertainment is how the media business maximizes distribution and ad revenues.
Unfortunately, entertainment isn't what I need to maximize my investment profits – and that's what I care about. How about you?
What Is “Knowable” Financial Advice?
Knowable financial advice is factual, as opposed to conjecture. Market valuations, company statistics (assuming they aren't being misrepresented), economic statistics, and market psychology are examples of current facts that are knowable and can be quantified.
“Weather forecast for tonight: dark. Continued dark overnight, with widely scattered light by morning.”– George Carlin
Another type of knowable financial advice is historical research showing how investment markets behaved under specific conditions in the past. The value of historical research is it provides a meaningful context to current facts.
It converts facts that would otherwise be dry and empty into actionable investment guidelines.
For example, you can know what the historical ten year returns for stock averages are given certain valuation and economic conditions.
You can also know if you're currently in the upper-end of the valuation range or the lower-end of the valuation range, and what your mathematical expectation for a ten year holding period would be starting today.
All these facts are knowable based on historical precedent. The problem is that the past may not be indicative of the future. The map isn't the territory.
“The trouble with weather forecasting is that it's right too often for us to ignore it and wrong too often for us to rely on it.”– Patrick Young
In other words, you can't know the future because the future is unknowable. Using the above example, financial statistics can help you know the ten year “expectation” for stocks based on history, but you must be equally clear that you don't know what stocks will do in the next ten years.
You have an indication and a statistical expectation given certain assumptions, but don't think for one minute that you can predict the future. You can't. Nobody can predict the future with statistical accuracy reliable enough to invest on. The future is unknowable.
This may sound like a subtle distinction, but it's not – it's critical. Remember, you must be clear on what's knowable and what's unknowable if you want consistent profitability investing into a future that's unknowable. (Hmmm, that's a mouthful!)
Knowable financial advice isn't based on someone's judgment, opinion, or interpretation – it's rooted in fact. This distinction is black and white, and it has the power to dramatically change your investing when you get it into your bones.
You should never put money at risk based on financial advice that's predicated on the unknowable. The unknowable includes predictions, financial forecasting, opinions, interpretations, stock forecasts, market forecasting, hunches, beliefs, or anything else not rooted in fact.
Why Most Financial Advice Is Really Just Financial Forecasting
Study the headlines, review brokerage analysis reports, and watch the investment media, and you'll quickly realize most of what passes for financial advice is really financial fiction.
It's blatant, unknowable futurism. Below are several examples:
- Ten hot stocks to own for the coming year
- Widget Inc's earnings are forecast to grow at 25% for the next five years
- Overpriced Inc. should trade in the range of $40-$60 per share
- Seven mutual funds to buy for next year
- Stocks will outperform bonds
- Real estate always goes up (an assumed truth prior to 2008)
- Our research indicates the economy will…
“If stock market experts were so expert, they would be buying stock, not selling advice.”– Norman Augustine
Notice that each of these all-too-common statements in financial literature require a crystal ball or direct connection to the Higher Power for there to be any financial relevance.
They might be blindly extrapolating past numbers to create future assumptions or communicating some conjecture about future events, but all of the financial advice above is based on the false premise that the future can be predicted.
And what happens when we invest money based on false premises? Ouch!
You can save a ton of time and money by ignoring all such nonsense. They're all statements about the unknowable because they require an accurate financial forecast to profit.
But My Stock Market Forecasting Is Accurate…
Sure, some financial analysts will make an occasional accurate call here and there, thus appearing to be great prognosticators of future events. But they can also be completely wrong the rest of the time.
The reality is a broken clock is accurate twice a day, but you would never use it to tell time. Why make the same mistake with financial advice that's really forecasting?
Betting on someone's belief about the future when they're wrong will cost you money, and financial advice that forecasts the future is wrong all too frequently.
To understand how financial forecasters rise to stardom, imagine a pool of 5,000 financial experts who toss their hat in the ring declaring themselves capable forecasters.
Let's say they're equally divided between bulls and bears. Next year, half will be right, and half will be wrong. The right ones declare themselves certified geniuses with a “proven track record” and go on to issue their infinite wisdom for next year's forecast and write a book.
Again, half are right and half are wrong, so we now have a pool of 1,250 financial experts with documented track records. Rinse and repeat for a few more years, and a few brilliant geniuses will bubble to the top with undeniably astounding track records and best-selling books.
The only question remaining is whether their track records are truly genius, or merely statistical anomalies?
“Thousands of experts study overbought indicators, oversold indicators, head-and-shoulders patterns, put-call ratios, the Fed's policy on money supply, foreign investment, the movement of constellations through the heavens, and the moss on oak trees, and they can't predict the markets with any useful consistency, any more than the gizzard squeezers could tell the Roman emperors when the Huns would attack.”– Peter Lynch
You can dismiss this oversimplified example as trite, but it's taken from a proven model used by disreputable financial managers to build the trust of naive investors.
They start mailing campaigns sent to massive lists of investors (100,000+) declaring they know the “secret” to the markets.
Each month, they send predictions and continue to follow up only with those who received the accurate predictions. The inaccurate prediction addresses are discarded.
After enough accurate predictions are delivered, they can usually establish sufficient credibility and trust with investors to extract some money.
After all, the huckster just sent you 10 accurate predictions in a row. You read them yourself. He clearly knows what he's talking about, right?
Relating this story back to the guru of the day, they usually follow a similar pattern before you hear about them. They usually publish books and newsletters.
In addition, they usually predict the future based on some indicator or theory that just happens to be working perfectly at the time and provides a logical reason for expecting more of the same in the future.
By the time you know about them, they have several books in print with an impressive list of documented predictions. It's hard to deny their brilliance – until you've been burned a few times.
The end result is always the same: the indicator or theory that perfectly accounted for economic behavior in the past suddenly stops working in the future. Their rise to infamy goes down in flames, and a new guru-of-the-day takes his rightful place on the throne.
Related: How Your Financial Advisor is Taking 75% of Your Retirement Income (or More!) Video, PDF download, or Audio.
When I began in the investment management business, Joe Granville had everyone's ear. He was so influential, his forecasts moved markets – until they didn't. Robert Prechter issued an amazingly accurate forecast of the great bull market of the 80s and 90s, only to turn bearish a decade too early.
Elaine Garzarelli rose to infamy only to fall off the radar screen. In early 2009, Professor Robert Shiller from Yale University has been as close to 100% accurate as I have ever seen, and Harry Dent is attracting a lot of attention.
Out of respect to each of the above names, their mention here should be taken as the ultimate compliment. These few were the best of the best who rose to the top.
Professor Shiller has an impressive pedigree beyond reproach, and Robert Prechter is extremely well-studied, intelligent, and well-reasoned. Their brilliance is what brought them deserved notoriety. They've succeeded (at least temporarily) in achieving the impossible.
For a period of time, they successfully predicted the future, but that too will change. Even the best and brightest must fall because the future is forever unknowable.
Every forecaster faces the exact same fate – they'll eventually be 100% dead wrong – and it will usually occur when they've attracted their greatest following.
If you bet money on their predictions, the damage to your portfolio can be devastating. You must have clearly defined exit strategies and risk control methods to protect your capital when the inevitable occurs.
It's as sure to happen as the sun rising in the morning.
Nobody knows the future with certainty. It's impossible because all predictions are at best probabilistic outcomes.
Eventually those probabilities must come home to roost and bite the forecaster in the backside. It has always been that way, and always will be that way.
It's inherent to the nature of the financial forecasting business.
Statistics Prove Financial Forecasting Is A Waste Of Time And Money
In case you aren't totally clear on the completely invalid premise behind financial advice based on forecasts about the future, or you haven't read the many research studies proving this fact, I'll quote directly from a transcript taken from the infamous Louis Rukeyser's “Wall Street Week” television show where he lays to rest any doubt:
“Now, before we meet tonight's special guest, let's take one of our periodic looks at why every self-respecting market technician treats the sentiments of his colleagues with contempt, as we track the embarrassing record of market advisors. So come along as we are ‘Gonna Take a Sentimental Journey'.”
“An economist is an expert who will know tomorrow why the things he predicted yesterday didn't happen today.”– Laurence J. Peter
“Our trip begins with the Dow at 689 on August 2, 1963, the first year Investor's Intelligence conducted the poll of market newsletter writers. With 91.4% of those surveyed bearishly calling for a short or long-term decline, and outright bulls at an all time low of less than 9%, the Dow then proceeded to rise 250 points in the next twenty-one months, which represented 38%.”
“Ten years later, in a week when the Dow was moving to new highs, nearly 62% of those polled thought the market would head even higher. And what came to pass? You guessed it. Down 470 points in twenty three months. Not surprisingly, by the time the Dow slipped to a twelve year low at 577 on December 13, 1974, the mood was glum again. More than 63% of market advisors surveyed called for further declines, and true to form, the market rose 425 points, more than 70% in fourteen months.”
“On January 14, 1977, with just 21% of advisers bearish, the crowd missed the mark once more as the Dow derailed with a 235 point loss over a period of fourteen months. And with the Dow at 784, the clouds hung heavy over Wall Street in anticipation of further declines, with nearly two thirds of investors feeling bearish.”
“The market, in turn, took off with a vengeance, rising more than 1900 points in five years. On August 28, 1987, the week the Dow touched it's then all time high at 2722, more than 60% of the advisers were, not to put a fine point to it, full of bull. Seven weeks later, the Dow, you may recall, was more than 900 points lower. On December 2, 1988, though just 21% of those polled were bullish, the lowest total since June, 1982. The Dow, then just under 2100, rallied an impressive 907 points in thirty one months.”
“If I have noticed anything over these 60 years on Wall Street, it's that people do not succeed in forecasting what is going to happen to the stock market.”– Benjamin Graham
Has anything changed in the years since Louis Rukeyser did this study on the predictive quality of financial advice for his television show? No.
In David Dreman's 1979 book “Contrarian Investment Strategy”, he analyzed 50 years of forecasts beginning in 1929. His conclusions were as follows:
- The experts dramatically under-performed the market
- Their forecasts outperformed only 23% of the time, meaning they were wrong nearly 3 out of 4 times
- As an example, the top 10 stock picks from a 1971 “Institutional Investor” magazine poll of more than 150 money managers in 27 states under-performed the market and were down 67% by the end of 1974
- Another example came from a 1970 conference poll of more than 2,000 institutional investors asked to pick the stock they expected to perform best. The winner was National Student Marketing which promptly declined 95% in value. Two years later, this same group's prediction was airline stocks, which then declined by 50% despite a general market rise.
How's that for forecasting?
“The findings startled me. While I believed the evidence clearly showed that experts made mistakes, I did not think the magnitude of their error would be as striking or as consistent.”– David Dreman on financial forecasting
The forecasting problem isn't limited to just the stock market, either. It doesn't work in any investment market with enough reliability to risk money on.
For example, James Bianco studied more than 20 years of interest rate predictions made by a panel of prominent economists published in the Wall Street Journal every 6 months.
Amazingly, this group of the “best and brightest” successfully predicted the direction of interest rates just 13 out of 43 times. They were wrong 70% of the time.
“That the beginning of a historic decline in stock prices is near is the single most crucial fact facing every investor and portfolio manager today. Anyone still invested and not selling into this market rise is ignoring the most crucial message from the stock market pattern since 1929… Today, the only certainty is that a great bear market of Supercycle or Grand Supercycle degree is due to begin this year and carry the Dow to below 1,000.”– Robert Prechter from his 1995 book “At The Crest Of The Tidal Wave” before the Dow Jones Industrial Average rose nearly 200% from valuations around 4,000
These economists are highly trained and highly paid to predict the future of long-term interest rates, and their accuracy is worse than throwing darts or flipping a coin.
If people who spend their whole lives predicting interest rates can't get it right, what's that tell you about the reliability of your mortgage broker, financial planner, newsletter writer, or neighbor down the street?
Did your financial advisor wisely get you out of stocks near the most recent market top? Were your investment magazines filled with bearish prognostications advising you to become cautious? I don't think so.
Did they ring the bell at the last stock market bottom and tell you to back up the truck and load up when opportunities were greatest? Not likely. Who told you to get clear of real estate before the bubble burst? Nobody! Exactly my point.
Sure, there were a handful of financial forecasters who got one or two of these calls right. But is there anyone with a proven track record of keeping you long during each of those multi-year bull markets and deftly stepping aside before the ensuing bear?
I don't know of any forecaster reliable enough to bet money on.
So why listen?
If financial forecasters are wrong when it matters most (and it has always been that way), what makes you think next time will be any different?
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Successful Investing Is About Risk Management And Business Analysis – Not Financial Forecasting
If financial forecasting is meaningless, and the bulk of financial advice is forecasting, then how should a smart investor make investment decisions? What can you rely on to create financial security?
“Prediction is very difficult, especially about the future.”– Niels Bohr
Smart investors who want consistent profits over the long-term develop an actuarial investment approach. They recognize that investing is about probabilities, not prediction.
Their decisions are based purely on known facts with the objective of managing risk and maximizing mathematical expectancy, much like insurance companies and many hedge funds manage risk and reward.
Profiting becomes a game of statistical certainty where the odds work for you rather than against you.
“It is impossible to trap modern physics into predicting anything with perfect determinism because it deals with probabilities from the outset.”– Sir Arthur Eddington
Investing in a professional, business-like fashion has nothing to do with picking hot stocks, predicting the future, guessing, taking hot tips, or any of the other typical approaches that pass for financial advice.
Instead, it's about following a disciplined, methodical investment strategy based on a known, positive, mathematical expectancy.
For example, Warren Buffett never knows what the market will do tomorrow and doesn't waste any energy on such nonsense.
He also doesn't know what stocks will outperform their peer groups over the next month or year because that's also unknowable.
“We've long felt that the only value of stock forecasters is to make fortune tellers look good. Even now, Charlie and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.”– Warren Buffett
What he does know is how to buy solid companies with valuable franchises at a fraction of their inherent value. Eventually, the market realizes the true value, and Buffett makes a fat profit.
Notice there's nothing about this strategy that involves reading a crystal ball. He utilizes past history and proven business principles to understand reasonable standards of valuation while employing present day factual data to determine current mis-pricings in the market.
No prediction necessary – just facts.
The bottom line is successful investing isn't about predicting the future, and any investment philosophy that requires you to predict the future is fundamentally flawed.
I repeat: any investment strategy that requires some prediction of the future is fundamentally flawed and should be avoided.
This one idea will eliminate most investment strategies and financial advice from your life.
I learned this lesson from the school of hard knocks, so please take what I'm saying to heart. I've left millions on the investment table and wasted untold research hours mistakenly pursuing the unknowable.
Learn from my errors and don't make the same mistake. Avoid financial forecasting like the plague and your portfolio will be happier for it.
This Isn't Rocket Science, But It's Very Profitable
If you want to invest with consistent profitability, then you must become clear on what you know, and equally clear on what will forever remain unknowable.
Predicting the future is unknowable. Period!
People seek forecasters because they want to feel some sense of control over the future. It feels gratifying to study the analysts' predictions, take action, and make things happen – even if it's completely wrong. At least you tried and did your best (or at least, that's what you believe).
Humans have an incessant need to control, whether it's spouses, nature, or their finances. To accept the future as unknowable feels out-of-control to the uninitiated, and that's intolerable.
“There are many methods for predicting the future. For example, you can read horoscopes, tea leaves, tarot cards, or crystal balls. Collectively, these methods are known as ‘nutty methods.' Or you can put well-researched facts into sophisticated computer models, more commonly referred to as ‘a complete waste of time.'”– Scott Adams
However, when you learn to invest based on mathematical expectation and risk management, much of what passes for financial advice becomes a meaningless waste of bandwidth.
When you learn to accept the future as a probabilistic outcome, you're suddenly free of many burdens the ordinary investor must shoulder.
You don't have to worry about being right or wrong. Instead, just align your portfolio with current probabilities while always managing against the risk of a large outlier loss. It isn't perfect, but it's profitable over time. It reduces risk, increases return, and allows you to sleep at night.
Investing is about making money. It's business.
Predicting the future is about ego gratification for the “genius” forecaster.
Never confuse the two.
Focus your limited time and resources on investment strategies that have statistical validity based on provable facts.
Nothing else is acceptable.
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