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The Prediction Game

By David Norton - February 15, 2016

[Estimated time to read: 3 minutes]

Who'd be a forecaster?  Politics…markets…sport… pundits frequently remind us that opinions which are freely given are usually worth exactly what they cost: zippo.

Two recent themes highlight just how hard the forecasters' roles have become.  Last year's UK General Election showed just how wrong forecasters can be.  And wrong to the extent that the rosy-cheeked Prime Minister hastily wrote a victory speech he never expected to be asked to deliver. 

And current markets are showing us just how hard it can be, even for experts, to predict outcomes accurately.  At the end of 2015, Goldman Sachs, the leading Wall Street Investment Bank, made a series of predictions on markets and suggested 6 trades to take advantage of them.  Goldman is renowned for its excellence, the sheer intellect of its people, and its unparalleled insights into finances and markets.  Within a couple of weeks, the bank closed, or gave up on, 5 of the 6 trades:  markets in 2016 have taken them so much by surprise, and those 5 trades have lost so much money that the bank has called off its bets.

If the supermen (and women) of Goldman, with their years of experience and billions invested in markets, systems and research can’t get it right, what hope have the rest of us?  It's easy, and tempting, to be cynical and to reject entirely the concept that investing can, in fact, generate returns.  It's worth looking a little closer to help decide what to do.

First, the Goldman example underlines why, for almost all of us, 'trading', as opposed to 'investing', is unlikely to have a happy outcome.  Markets are simply too unpredictable, with too many influences, to accurately predict over the short term. 

Second, this is why it is so important to understand what volatility is: a strict definition has it as 'the degree of variation of prices over time'.  The key point here is 'time'.  One of the reasons that successful investors take a long term view is that, over that long term, performance is fairly predictable.  This is because the short term is, literally, un-knowable but the long term irons out the volatility that dooms short-term trading to guesswork and luck.  Worse, the crisis of 2008-9 showed that some markets are stacked in favour of the biggest traders and the owners, and operators, of the markets. 

Third, it means that investors need to be careful to understand which investment approach to follow:  to trade specific, short-term ideas in the hope of making quick profits; or take long-term investment positions that have the benefit of time to generate returns over years.  It's no surprise that we advocate the second approach:  history shows, time and again, that a stable, long-term investment approach across a diversified asset base is the most effective way of protecting and generating wealth.

But what of current markets?  There is no doubt that it is painful.  Most of us have some investments already – which means that 2016 has seen a significant decline in their value.  This is painful, and it leads to some classic behaviours and emotions:  we wish we had followed our thoughts last summer to take profits; we wish we had ignored the adviser who suggested an investment, and we wish we'd simply stayed in cash.  The point of a long-term investment approach is that history proves that investors are rewarded for staying the course. So the many investors who are asking us what to do are getting a simple answer:  don’t panic, good investments are going to recover in due course, and selling into panicked markets has ALWAYS been the wrong thing to do.  Most of us know that it's impossible to time markets – that's what the Goldman experience proves.

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