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Why You Shouldn’t Listen to Predictions When Investing

Ser Jing - Why Investors Shouldn't Trust Predictions (pic)

Yesterday night, I came across a very interesting table about the results of the predictions, made at the start of the year, on where the S&P 500 Index (a widely-followed American stock market bellwether) would end up by 2013’s end.

The predictions were made by analysts from some of the biggest and most well-known financial institutions – think Wells Fargo, Goldman Sachs, JP Morgan, Barclays – but yet, as you’ll see shortly, they’ve all fallen flat on their faces.

I’ve reproduced the table which I first saw on financial blogger and professional investor Barry Ritholtz’s blog. For reference, the S&P 500 closed on Wednesday night (11 Dec 2013) at 1,782.

Institution

S&P 500 Target

% Miss (as of 12 Dec 2013)

Wells Fargo

1,390

28.2%

UBS

1,425

25.0%

Morgan Stanley

1,434

24.3%

Deutsche Bank

1,500

18.8%

Barclays

1,525 16.9%

Credit Suisse

1,550

15.0%

HSBC

1,560

14.2%

Jefferies

1,565

13.9%

Goldman Sachs

1,575

13.1%

BMO Capital

1,580

12.8%

JP Morgan

1,580

12.8%

Oppenheimer

1,585

12.4%

BofA Merrill Lynch

1,600

11.4%

Citi

1,615

10.3%

Average 1,534

16.2%

Source: Business Insider

It’s a rather sad state of affairs to see all these hallowed institutions get their guesses all wrong, some by more than 20%. But the thing is, this shouldn’t be a surprise. One of the most well-known studies on mankind’s fallibility with predictions of the future comes from psychologist Philip Tetlock.

In the 1980s, Tetlock started his project and eventually ended up studying more than 25,000 expert predictions in domains such as economics and politics. His conclusion: expert predictions are no better than random guesses.

So if expert predictions can’t really be relied upon, what can investors do?

It’s simple really. They can stick with methods that give them good odds of success: buying cheap stocks and holding for the long-term. In that way, there’s no need to rely on prediction – you’re just sticking with what works.

But since we’re on the topic of predictions, and assuming I have to make a prediction, here’s what I predict the Straits Times Index (SGX: ^STI) will be in 10 years’ time based on its current earnings figure of around $250 per share:

Straits times index

Take your pick from those figures above. Within such a matrix you can find “the most honest forecast anyone can give for where stocks will be in 10 years”, according to my colleague Morgan Housel.

Does it seem to not be useful at all given the wide range of possible outcomes? Well, that’s the point.

By giving ourselves wide room for error, we’re 1) acknowledging the fact that it’s very tough to get predictions right, and 2) we can build up a margin of safety in our investing activities with which we can still stand a good chance of making profits even if reality ends up at the lower boundaries of our predicted-scenarios.

Ultimately though, it’s perhaps best to acknowledge the inherent difficulties in predicting the unknown – that is, the future – and try our best to stay out of the prediction game as much as possible when investing. And more importantly, take experts’ predictions with a pinch (nay, a ladle) of salt when it comes to using them for making investing decisions.

Remember: The odds aren’t with you if you’re betting on those predictions being proven right.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn’t own shares in any companies mentioned.