The danger of predictions (and why I don't predict).
"Those who have knowledge don't predict. Those who predict don't have knowledge." Lao Tzu
There is a pervasive problem in my industry (and the media) with people pretending they know stuff that they really don't. People are always predicting what is going to happen in the future - a recession is coming in June, the market will crash in October - it goes on and on. In a recent piece Morgan Hounsel made a differentiation between an expectation and a prediction. It's an important point.
Here are some things that I (and he) expect.
- I expect that at some point every year the market will fall somewhere between 10% and 15%.
- I expect that roughly every five years the market will fall 20% or more.
- I expect that three out of four years will give positive returns.
- I expect another recession at some point.
- I expect that my clients will have some investments that will do well this year and some that won't do so well.
None of these statements are predictions.
"An expectation is an acknowledgement of how things worked in the past and will likely work in the future. A forecast is strapping that idea to a specific point in time." - Morgan Hounsel
Let me flesh out the statements above:
- I expect that at some point every year the market will fall somewhere between 10% and 15%, but I don't know if that will be in January, June or December.
- I expect that roughly every five years the market will fall 20% or more, but I don't know in which year it will happen.
- I expect that three out of four years will give positive returns, but I don't know which year will be negative.
- I expect another recession at some point, but I have no idea when.
- I expect that my clients will have some investments that will do well this year and some that won't do so well, but I don't know which will be which.
Expectations are really critical because they prevent us being surprised. If I expect the market to fall by 20% or more at some point then I won't be surprised when it happens. If we don't expect it we are much more likely to panic. And as you know, nothing good ever comes from panic.
The chart below is a great visual reminder of why we should not make investment decisions based on predictions.
The thing about looking into the future is that mostly we underestimate all the great things that will happen, and we focus on the negative. I always love the story of the Great Horse Manure Crisis of 1894. The streets of London and other large cities around the world were suffering from a horse manure problem. In 1894 The Times newspaper predicted...
“In 50 years, every street in London will be buried under nine feet of manure.”
It was so bad that the situation was debated in 1898 at the world's first international urban planning conference in New York. The brains could come up with no solution. The conclusion literally was that urban civilisation was doomed.
Fast forward a decade or so and Henry Ford had saved the day!
So, remember, expectations are about looking at the past and making rational assumptions about how things will continue in the future. Predictions are a fools errand. It's wise to know which you are acting on.