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Money: The boy who cried wolf

23 Jan 2018

The start of the year brings a flood of forecasts, most of which turn out to be hopelessly wrong.

A chief economist is telling us to cut our exposure to shares in 2018. So, I checked his other forecasts and sure enough, in 2015 he was telling us that China was leading us into a global recession. He was 70% certain.

We now know it didn’t happen.

Much more sensible are the words of another chief economist who stated recently, ‘economists should not make forecasts.’ I would add, ‘neither should investment managers or advisers’.

Forecasting is marketing. They are appealing to our optimism that someone can predict the future and save us from the next market downturn.

Forecasters rely on you forgetting their prediction by the time it all comes to pass. And in that sense forecasting is dishonest. Perhaps it is entertaining for some, that would be fair comment, and if there were no other consequence to the forecasting game, it probably wouldn’t matter.

The problem is, of course, that some forecasts turn out to be right, in hindsight. Is there any way of working out which forecasts are right ahead of time?

Wrong, or lucky? Take your pick.

Investment forecasts can only be one of two things – wrong, or lucky. And luck is a bad foundation for making investment decisions.

What are some good foundations for making investment decisions upon? This gets interesting, at least, for me:

  1. Have a long-term plan and stick to it. Set your goals and check your progress once a year.
  2. Make sure your plan is designed to cope with an uncertain future. If you are not sure about your plan get help.
  3. Diversification is the only free lunch.
  4. Expect surprises. Something will happen in 2018 that no-one saw coming.
  5. You will be tossed around emotionally by whatever happens in 2018. We are programmed as humans to be subjected to numerous biases. We have had pretty good returns for five years in a row and this fact affects our judgement. Some of us will be over-confident thinking it will continue for ever; others will be expecting a reversal of fortune and wanting to wait and buy when markets have fallen. No matter what our biases they are all to our detriment, if we allow them to influence our behaviour.
  6. The sector your investments are in is much more important than the underlying investment itself. A poor investment in a sector that is rising will do better than a great investment in a sector that is falling. Choose your sectors wisely.
  7. There will be an investment type that you wished you owned more of. Every year some sectors do really well while other sectors do really badly. All that means is that you are well-diversified.
  8. Don’t expect to shoot the lights out. The top performing investments have higher risk, by definition, and they will revert at some stage. Aim to be in the top half of investment returns and you will achieve your goals in the long term.

Keep asking great questions …

Rhodes

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