If an Addiction to Prediction Is Detrimental to Your Investing Health

“Those who have knowledge don’t predict and those who predict don’t have knowledge.” – Chinese proverb (attributable to Lao Tzu)

Investors, like all people, are drawn to predictions; especially those that play to our natural fears of the unknown. Many of these signs and projections are intentionally constructed in a storytelling format designed to alleviate our anxiety over being uncertain. Today anyone calling themselves an analyst can find a platform to share their views on the market. Unfortunately, according to a study* by CXO Advisory Group, an investment research firm, the average accuracy of all pundit data points was 47.4 percent (slightly worse than your odds with a coin toss).

The fact is, investing is an inexact science and it will always have an aspect of uncertainty. Additionally, investors do their decision-making abilities a great disservice when they resign themselves to a state of denial concerning uncertainty in their investing. The result of this resignation is ambiguity which is the polar opposite of clarity. While many feel it may be counter-intuitive to embrace uncertainty (also known as volatility), doing so has been proven to enhance decision-making skills and far outweighs the damaging effects ambiguity can have upon investors. Ambiguity renders investors that are unable to manage the factors they can actually control; such as knowing what companies they are invested in and why.

Why do Investors Insist on Using Forecasts in the Investment Decision-Making Process? 

First, investors live under a veil of uncertainty when they do not have a clear understanding of what they own and why they own it. To soothe the fear caused by uncertainty, they anchor their hopes to any data points that help substantiate their portfolio decisions, regardless of how irrelevant the data may be. Denial of uncertainty and the allure of storytelling drive people to repeatedly subject themselves to meaningless predictions despite their ineffectiveness.

Too many people, especially investors, analysts and money managers, are overconfident about their ability to predict the unpredictable. While this keeps soothsayers, market pundits and internet trolls in business, it is a terrible way to build an investment portfolio. Embracing uncertainty (knowing that you cannot control the future) or at least having a healthy respect for it, leads to better decision-making.

A reliance on stories when gathering investment information is another futile method of compensating for uncertainty. According to research by Hastie and Pennington**, people rely heavily on stories they either construct themselves or are told by others to reach decisions, instead of accessing standalone evidence. Known as explanation-based decision making, stories can be more comprehensible, persuasive and memorable than charts and spreadsheets. They cater to our need to make sense of date we don’t understand and cope with the discomfort of that uncertainty. However, a focus on narratives can be a major driver of some damaging investment behaviors, such as confirmation bias. True clarity is not gathered from a whippy anecdote but by profoundly understanding the money manger’s core philosophy and strategy.

The second reason that investors rely on the pursuit of forecasting in their decision-making process is rooted in overconfidence. According to a 2006 study*** “74% of the 300 professional fund managers surveyed believed that they had delivered above-average job performance. Of the remaining 26% surveyed, the majority viewed themselves as average. Incredibly, almost 100% of the survey group believed that their job performance was average or better. Clearly, only 50% of the sample can be above average, suggesting the irrationally high level of overconfidence these fund managers exhibited.”

What Can be Done to Break this Endless Chain of Addiction to Prediction? 

Here are simple steps to break a reliance on senseless and irrelevant forecasts that simply do not work:
• Focus on your destination rather than the journey. Investors place entirely too much emphasis on day-to-day and near-term market performance. As an investor, determine what you are trying to accomplish and work with an advisor and money manager whose strategy align with those goals.
• Stop pinning hopes on market calls, short-term tactical shifts and algorithmic machinations in generating market returns. Instead, rely on the long-term historical precedence stipulated by facts and supported by wealth generation created by owning solid businesses over the long haul. Acknowledging uncertainty allows money managers to focus on the probabilities of outcomes rather than conjectures.
• Locate a money manager who concentrates on a few key elements in the selection process and is able to readily and clearly articulate those to you. There are several strategies that don’t need forecasts as inputs, such as intrinsic value and dividend capturing. We call this clarity of philosophy and strategy.
• Do not believe everything you read or hear. Hyperbole is rampant in today’s environment on both the ultra-bearish and bullish side. Detach the ripcord to spurious anchors that soothe our fears of uncertainty. An honest assessment of differentiating between what we know and don’t know is emotionally healthy.
• Embrace uncertainty and make it your ally. Acknowledging uncertainty allows you to focus on the probabilities of outcomes rather than conjectures.

The more you understand about the business or businesses you own, the more clarity you have in making investment decisions. If you have investment clarity, then predictions are irrelevant. If you have investment clarity, you focus on the philosophy, strategy, flexibility and transparency of how a business owner runs their business – not on predictions.

Mark Pearson is the Founder, President and Chief Investment Officer of Nepsis, Inc., a SEC registered investment advisor firm based in Minnesota. He is responsible for the firm’s strategic vision, research and trading decisions. Mark’s unique back-to-basics investment philosophy, Invest with Clarity® was developed to teach investors to invest like they are business owners – that is knowing what they own in their portfolios and why they own it.

*A CXO Advisory Group study collected 6,582 forecasts for the U.S. stock market made by 68 market commentators between the years 1998 and 2012.
**Explanation-based decision making, Hastie, R., & Pennington, N. (2000).
***Behaving Badly by researcher James Montier (2006).