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Thou Shalt Not Be a Financial Prognosticator!

Posted on November 22, 2019

Recently I have fiddling with this thing called the Portfolio Visualizer. It is an excellent website with brilliant simulators for understanding past performance of investments. It has something called a Backtest Portfolio, which helps you see what various returns would be using different asset classes or specific funds over the years.

It is very interesting to check, for instance, how much you would end up with today if you put $10,000 into the Vanguard Total Stock Market fund (VTSAX) back in 2000 (The answer: over $36k…which, incidentally, is less than you would have had if you had waited until 2009 to invest, because of the so-called “Lost Decade” of the Aughts, which featured two large crashes).

It’s pretty fricking cool to see all the information displayed so simply and elegantly in the Portfolio Visualizer. Of course, this kind of thing is what got me excited about the Callan Periodic Table of Investment Returns, which also provides a wealth of information that can show us how different funds performed

In the past.

And that is the rub. It can be so fun and exciting, easy really, to look over how things have done in the past. The problem starts when we start thinking that the future will be the same as the past. How relevant is the past for predicting what will happen? Even if history rhymes, as Mark Twain said, how is that likely to work out when it comes to something like investments? Are our conclusions, based on looking at what has occurred, useful in predicting what will occur?

When you look back, all the answers are there: it’s easy to know all the sports scores, all the weather conditions, and all the winning lottery ticket numbers. The problem is, you really can’t live with your eyes focused on the rear view mirror…. after all, it’s the stuff in front of you that is coming at you.

And it may not look at all like what is behind you, receding into the background.

As they say in all the investment literature: “Past performance does not predict future results.”

Ah, but how tempting it can be to try to predict anyway! How are the markets going to move? What will happen next? Maybe if I study enough data, then I will know! I will have figured out! It could be possible!

Of course, I’m telling on myself here. I noticed my own brain trying to figure it all out recently, and it was very stressful… and I still haven’t come up with the answer. Our brain is full of cognitive biases, ie distortions of reality. One such cognitive bias is recency bias, where we think that what has occurred recently is likely to occur again.

The fact is, we humans try to predict anyway, and we often use recent past performance to do so. Which is why I think it’s very important to be skeptical of our own brains, and take our own conclusions about the future (and this probably stands for many things, not just investing) with a grain of salt.

I shall endeavor to minimize financial prognostication*! And even if I see myself trying to do it, I will remind myself that my crystal ball is in the shop for repairs… permanently 🙂

*In case that word is a little esoteric, it’s a clever way of saying, “trying to predict the future.”

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