Why Expert Predictions Are Worthless
I wrote a blog last year about a McKinsey study that found that media analyst predictions about S&P 500 earnings growth have been significantly wrong almost every year out of the last 25. Now, thanks to a recent book by Dan Gardner, Future Babble, we can understand why.
Gardner pulls together compelling evidence to explain that expert predictions fail for two main reasons. First, the world is too complicated to be predicted. Think about how many variables influence economic growth. Or stock prices. We simply do not have the mathematical and computational tools to predict these kinds of things with any sort of accuracy. But the second reason may be even more profound. It’s the way our brains are wired. People have an instinctive aversion to uncertainty. We want to know what is happening now and what will happen in the future, so we try to eliminate uncertainty any way we can. We see patterns where there are none. We treat random results as if they were meaningful. And we embrace simple narratives that replace the complexity and uncertainty of reality.
Enter the experts. They have certifications, awards, and most of all, confidence. These are the kinds of people the media loves, with its preference for the simple and the dramatic. These experts communicate as if they are certain what will happen, and we like that because that is the way we want to feel. We believe them because we want to believe them. And therein lies the trap. The truth is there are no crystal balls and no techniques for predicting the future. But there will always be fortune-tellers and prognosticators as long as we want to hear what they are telling us.
In addition to many examples of experts that got it completely wrong – he recalls Stanford University biologist Paul Ehrlich’s wildly pessimistic prediction in The Population Bomb (1968) that by the end of the 1970s there would be massive famines because the world would be unable to feed its exploding population – Gardner cites numerous studies that explain many of the emotional biases towards investing that come under the field of behavioral finance. And he points out that most expert predictions tend to be a continuation of current thinking rather than something unique. It’s a lot easier to see down a straight road than to see around a curve. Remember December 2008? How many experts at that time were predicting that by the end of 2009 the S&P 500 would bounce back over 26%?
You owe it to yourself to heed what this book is saying. As much as investors might like to believe what someone like Jim Cramer is telling them, Gardner makes it clear that such people know no more than you do about future stock performance. The safer way to invest is simply to keep your portfolio as diversified as possible across asset classes that tend not to be highly correlated with each other. That way you don’t even need to worry about predicting the future. As long as there is economic growth over time, the value of such a portfolio should continue to increase.
Never forget the words of that famous malaprop Yogi Berra: “It’s hard to make predictions…especially about the future!”