Toward the end of the old year and the beginning of the new one, a strange compulsion begins to come over financial pundits, investment officers, advisors, and anyone who opines on financial matters. It is the Call of the Forecast. Predictions will be made as to what interest rates will be over the coming year; how many times the Federal Reserve will change rates; what will happen in the stock market (TV news in particular loves these opinions); how the dollar will move compared to various other world currencies, especially the euro. Et cetera.
The Call of the Forecast is understandable, given that our brains are wired in certain ways to enjoy prophecy. One of the cognitive biases is the “illusion of control”, or our tendency to believe that we can control uncontrollable outcomes. Market behavior is not predictable and no one person has influence over it. However, conjectures about the future provide the illusion that someone knows what’s going on, and that implies some measure of control.
Given the inherent volatility of the markets, often forecasters differ from each other. (Not to mention that a creature called the “perma-bear” exists: someone who is pessimistic about the market and believes it will lose money in the next period of time.) Therefore, our confirmation bias will be validated: at least one pundit will provide a forecast that agrees with whatever we think or feel will happen, whether we think it will be a good or a bad year in the markets.
If you read or watch financial news, you will see the anchoring/focus effect at play. Anchoring is where you “anchor” to or focus on a piece of information, whether it is still appropriate or not. 2013 is a great example of this. Who at the beginning of the year thought it would be a great stock market year, given the economic climate? In addition, there was a government shutdown in the middle of it. However, at the end of the year, large company stocks were up 32% and small and mid caps up over 40%.
These are just some of the biases at work that support our desire for forecasts. The problem with annual predictions in the market is two-fold.
One, no one has a crystal ball. If they did, they wouldn’t be on a cable news show talking about their predictions – they’d be unfathomably rich. With the uncertainty inherent in the markets, there is a chance the forecaster could be right, and somewhat more likely that they’ll be wrong, especially if their forecast is specific. An advisor who says the market will increase in the coming year has a decent shot at being right, but an advisor who says large caps will be up 10% has a far larger chance of being wrong.
Multibillionaire Warren Buffett, one of the most successful investors ever, doesn’t have a crystal ball. He doesn’t make market predictions. It doesn’t matter to his investment process what the markets or interest rates or the Federal Reserve or the president of the United States is doing. He carefully investigates the companies that he buys, and if the company makes it through his filters, he buys it.
Two (as illustrated by Warren Buffett): annual forecasts are largely irrelevant to the average investor. Properly allocated portfolios will have cash for the coming months’ expenses, to avoid having to withdraw money from stocks that are dropping. Whether the market is up or down or sideways has no bearing on cash. For long-term investors, one year (or even four) of a market drop is not so important with a 10, 20, or 30+ year time horizon. Those who are close to retirement might feel a bit more nervous, but again a properly allocated portfolio at this stage of life will have cash and bonds that are not affected by a stock market drop, that can provide funds until the market recovers.
Ignore the Call! Or, if you want to have a little fun with it, note the predictions of your favorite commentators or prognosticators at the beginning of the year. At the end of the year, see how they turned out, and whether the predictions had any effect on you during the year. You can make predictions for fun, too – even if you don’t know what you’re talking about. You could end being right, from pure chance! But don’t let your portfolio be swayed by the Call.