Monday, January 24, 2011

What's Next?

Here is an article from the Boston Globe which discusses how poorly "experts" do at forecasting the future.  This is a great follow-up to last week's post about efficient markets.  

A common belief is that, while maybe the average person can't predict what will happen next, surely there are experts out there who can.  A look at the actual track record of these "gurus" quickly dispels this notion.  In the above mentioned article, the author discusses Nouriel Roubini, the man who, in 2006, predicted the financial crisis of 2008 and, thus, earned the nickname "Dr. Doom".  This correct prediction earned Dr. Roubini fame and fortune.  Unfortunately, it was also followed by many incorrect predictions, such as excerpted below from the Globe article:

"But here’s another thing about him: For a prophet, he’s wrong an awful lot of the time. In October 2008, he predicted that hundreds of hedge funds were on the verge of failure and that the government would have to close the markets for a week or two in the coming days to cope with the shock. That didn’t happen. In January 2009, he predicted that oil prices would stay below $40 for all of 2009, arguing that car companies should rev up production of gas-guzzling SUVs. By the end of the year, oil was a hair under $80, Hummer was on its way out, and automakers were tripping over themselves to develop electric cars. In March 2009, he predicted the S&P 500 would fall below 600 that year. It closed at over 1,115, up 23.5 percent year over year, the biggest single year gain since 2003."

Now we have nothing personally against Mr. Roubini, but this is an example about why we do not use prediction as a tool in financial planning, because, in the end, the ability to be right about the future, even among well-informed, well-educated experts, looks a lot like luck.  We think planning one's financial future should involve understanding cash flows, risk/return trade-offs, and other mundane financial concepts -- not betting on anyone's predictions.