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RP: The investing industry is full of people who claim to be able to predict the future. You often see them quoted in the media.
But forecasting developments in the economy and movements in the stock market is notoriously hit and miss.
ED: It’s a very difficult thing to do. What we can predict is volatility: when markets become volatile and start moving up and down. Then, after a period of volatility – which might be when the market has jumped up, or might be after the market has declined – the likelihood of an extreme move is amplified. So in that sense: we can predict when a market is more likely to fall, but it’s also going to be more likely to increase in value.
RP: Market forecasts often seem very plausible.
But the truth is, that no-one knows whether, in the short or medium-term, markets will go up or down.
ED: It’s quite popular at the turn of the year for predictions that appear in the financial press. What you tend to find is that commentators extend trends more often than they forecast reversals. So, if you see that markets have been going up, what you find is that the forecast for the next quarter or the next half-year or the next year is more likely to be favourable, than to predict that there will be a crash.
RP: The problem is: it’s human nature to want a degree of certainty.
The global economy and financial markets are hugely complex. We want to think there’s someone out there who knows exactly what’s going on.
ED: Your investment performance depends on three things: the price at which you bought, the income you get over the periods while you hold the investment, and the price at which you sell. So market timing, since people will often be buying exposure to the market, must involve asking whether it’s a good time to buy (in other words, whether prices are likely to go up), when it’s a good time to sell (to avoid a decline). So it’s natural to focus on that as well as on the level of income that might be generated by an investment.
But there is a problem. And the problem is that, oftentimes, when people make a prediction, they get it wrong; and the cost of, for example, trying to avoid the worst times or capture the best times is that you might get it completely wrong. And that simply increases the risk over the long-haul of your investment portfolio.
RP: So, although it’s very tempting to listen to market forecasters, we shouldn’t take their predictions too seriously.
The best approach, as Professor Dimson says, is to be prepared for all eventualities — and to ride out those inevitable periods of volatility.
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