Wed. Dec 8th, 2021

By Dr. James M. Dahle, emergency physician, founder of the WCI

P. There are so many opinions among gurus and “speakers” about what the stock market will do in the future, interest rates, inflation, house prices and cryptocurrency. I’m not sure who to listen to. Any advice?

A. The CXO advisory group once examined thousands of stock market predictions of dozens of financial gurus over a 15-year period. He found that gurus (i.e., public commentators) were only correct about 47 percent of the time; on average, an investor would have been better off simply tossing a coin. Gurus are paid to opine and not to be correct. In fact, marketed correctly, a good (or perhaps lucky) prediction can consolidate a commentator’s reputation for decades.

However, the truth is that “no one knows anything.” When investors realize that there is no reliable resource that will give them the future returns of various investments or the direction of interest rates, it can be an immensely liberating experience. Suddenly, those investors realize that trying to play the system is a waste of time and energy. Instead, they can focus on the factors they can control, such as how much they earn, how much they save, and their overall combination of investments.

Some people think they can really make good predictions. I suggest an exercise. Get a notebook. Write it down every time you have a prediction about the future return on a particular investment. Be specific. Don’t just write, “I think Tesla will do well.” He writes: “I think Tesla will outperform at least 3% in other high-growth companies in the next six months.” Do the same with interest rate projections, house prices, inflation, and anything else you think you can predict with any degree of accuracy. Circle the circle and see how many of your predictions turned out to be correct. In a year or two, you’ll probably be convinced that your glass ball is as cloudy as anyone else’s. As investors, we are not always rational. In retrospect, we thought it was much easier to predict the future than it was. Only honest evaluation of an exercise like this can reveal this bias.

How to invest?

There are many types of investments or asset classes. These include various types of stocks, bonds, real estate, commodities, coins, precious metals and others. An investor does not have to invest in everything and, in fact, there are no “so-called strikes” in the investment. If you don’t like a particular investment, you can get a pass. There will be another “pitch” soon. However, it is likely that all asset classes will have the day in the sun. These time periods are usually preceded and followed by periods of low performance. These investment cycles are natural and should not be a cause for concern for a long-term investor, especially because the cycles are much shorter than a typical investment career.

investing with a crystal ball

Consult Zoltar before investing? What makes you think you can better predict the future?

The natural inclination of an investor, unfortunately, is the “pursuit of yield.” Investors, as a whole, accumulate investments after they have done well and seem to redeem the investments just before they start doing it again. This translates into high buying and low selling repeatedly. Too often, this can prevent an investor from achieving even reasonably modest financial goals. One of the best ways to avoid performance tracking is to periodically use a static asset allocation and rebalance it.

A static asset allocation means that you divide your portfolio between the various asset classes you want to invest in and assign a percentage to each investment. You may have decided to invest 30 percent in U.S. equities, 20 percent in international equities, 25 percent in bonds, and 25 percent in real estate. In the future, regardless of the performance of each of these asset classes, at the end of the year rebalance the portfolio with the original percentages. If the bonds have had a particularly good year and the stocks have been bad, maybe your portfolio is now made up of 25 percent US stocks, 15 percent international stocks, 32 percent bonds and 28 percent real estate. So, sell some real estate and lots of bonds back to your original 30-20-25-25 asset allocation. The following year, international stocks may do especially well, so you will sell part of that asset class at the end of the year and buy more stocks, bonds, and real estate in the U.S.

In the early years, investors often do not need to sell the asset class with excessive returns. They can simply direct new contributions to asset classes with lower returns than those to keep the portfolio in balance.

Maintaining a static asset allocation and rebalancing periodically ensures that investors sell consistently high and buy low, or at least do not do the opposite. More importantly, investors maintain the desired level of risk in the portfolio. The best part of this approach is that it does not require investors to know anything about what will happen in the future to be successful. Investors are free to try to guess future returns. They are much less likely to mistakenly assume that past performance indicates future performance, such a bad idea that the law requires mutual funds to tell you that such guarantees can never be made.

Successful investors know that investing is a single player game, against their goals. They avoid making mistakes for fear of getting lost (FOMO) and adhere to their written financial plan. They know that achieving their goals depends much more on saving enough money and controlling the risks than on “attacking at home” with their investments. Just as many singles and doubles win baseball games, a slow and steady saving on a periodically rebalanced static resource allocation leads to a life free from financial worries.

[Editor’s Note: This article originally published at ACEPNow]



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