Short-term investment predictions do not work
July 16, 2015
Today we are going to make a bold stock market prediction. Consider this our “hot tip.”
We strongly predict that you will never be able to constantly predict the short-term outcome of the stock market or any individual security. Yes, from time to time you will guess the market correctly but that can be attributed to luck versus skill.
We also predict that you will ignore our prediction.
There are two ways that you can make stock market predictions. The first is to develop your own criteria on how to guess the future and then follow those predictions with investment decisions.
The second way is to delegate someone who will make predictions on your behalf. This can be a stockbroker who specializes in buying and selling individual securities or a mutual fund manager who does the same security buying and selling on behalf of the mutual fund owners.
The reason for our bold statement that investors do not have the ability to outguess the market is based on evidence. The evidence comes from studying 70 years of academic peer-reviewed research and 100 years of analyzing investment results from individual investors and investment managers.
The simple answer is that making investment predictions is nothing more than guessing and the evidence strongly concludes that guessing does not work. Continue investing in this manner at your peril.
Warren Buffett has an opinion on those who attempt to predict the stock market’s performance that is in line with the evidence of investing. He is considered to be an icon in the investment community. Buffett said:
“We’ve long felt that the only value of stock forecasters is to make fortune tellers look good. Even now … I continue to believe that short-term market forecasts are poison and should be kept locked in a safe place, away from children and also from grown-ups who behave in the market like children.”
Our recommendation is not to attempt to outsmart the market. We recommend your investments be broadly diversified, low cost and tax effective. Your goal is to capture as much of the market returns as possible.
That brings us to our next prediction. Will you be able to predict your market returns in the market from a broadly held well diversified portfolio year to year? The answer is a definite no.
The stock market in the United States as measured by the Standard and Poor’s 500 index has produced long-term returns ranging from 8 percent to 10 percent annually. That is in no way an indication that you should expect similar returns every year.
The stock market is volatile. Starting in 1926 there were 28 years when returns in the S&P 500 were gains or losses in excess of 25 percent.
Over time, investing in the stock market has been very profitable and predictable but we stress the “over time.” The short-term returns have been extremely volatile and there is no reason not to expect that volatility to continue.
Any time you have a market that is extremely volatile it is almost too tempting to resist predicting future market swings in order to capture significant financial gains. There is a little bit of “greed” in us all.
Imagine if you could time the market and miss a decline of 28 percent one year and then capture an increase in value of 28 percent the next. Your investment portfolio would grow exponentially.
That curiosity to fuel our natural greed is what most of the investment media coverage is all about. People take great delight in making bold predictions and from the perspective of the entertaining world of investment journalism that is something the readers will pay for.
Our recommendation is to remind you that what you read, hear on the radio or watch on television is nothing more than investment entertainment and should be correctly categorized under the heading of fiction.
Investing is serious business and achieving many of your life goals is based on successful investing in order to fund those goals.
Predictions are guessing. Investing is not guessing.