The investment world has been slow and, in many cases, averse to accept one simple truth: The future is unknowable and unpredictable, playing out a second at a time.
For many generations, the whole idea behind hiring a stockbroker or investment advisor was that a trained expert could look into the future and tell you what to do.
Leveraging his or her superior knowledge of companies and markets, and supported by the additional expertise of researchers, analysts and economists, the broker could confidently tell you which companies and industries were most likely to outperform the market, and when to buy and sell.
The message was clear for individual investors: Financial professionals just knew more and could see into the future in ways that regular people never could. If you were lucky enough to have a broker, his or her recommendations were your best chance for success.
Remember EF Hutton’s classic ads?
“My broker’s EF Hutton, and EF Hutton says…” The mahogany and leather dining room goes silent, everyone waiting for the sage, omniscient pronouncement of future market events.
Surely one of the great ad campaigns of all time, this perfectly captured Wall Street’s premise that financial professionals knew what the future held.
But guess what?
It doesn’t work that way.
EF Hutton couldn’t foretell stock prices in 1977, and Merrill Lynch and Morningstar can’t do it today.
Impossible to predict
I can’t tell you if the S&P 500 Index will go up or down tomorrow.
I can’t tell you if telecom will outperform banking for the rest of the year.
I can’t tell you if gold is ready to surge or plummet. No one can.
Anyone can guess – some will guess right – but no one knows.
Market movements can’t be reliably predicted. Especially in the short term.
This is not a grumpy old man’s contrarian opinion. This is fact, supported by decades of academic research. Each year, more data appears showing that simple buy-and-hold investment strategies, on average, beat prediction-driven strategies based on picking stocks and timing the market.
This evidence is slowly getting some coverage in the mainstream media, but in the financial services universe it’s old news. Brokers know it. Fund managers know it.
Still, prediction flourishes.
Brokerage firms predict stock price targets.
Analysts predict the performance of specific stocks and sectors through buy and sell recommendations.
Economists predict gross domestic product, interest rates and changes in inflation.
Financial media pundits predict how security prices will react to events like elections, economic reports and natural disasters.
Mutual fund managers predict winners and losers through the stocks they choose to include in their funds.
Brokers predict by picking stocks for their clients.
The business models of all these players rely on prediction of an unknowable future. Whether their predictions are based on proprietary computer models, historical analysis or educated guessing, all these people make money by selling their predictive abilities to others.
All these companies and careers rely on prediction despite all of the empirical evidence showing it’s not possible to systematically outperform the market based on prediction.
Here’s my favorite business model in the prediction business: A pension fund or other big institutional investor hires five or 10 money managers to apply their predictive skills to invest pieces of the portfolio. The fund then hires one or more consultants to monitor, evaluate and rate the money managers, and to predict which of them should be trusted with the largest pieces of the portfolio next year.
That’s right. A predictor is hired to predict which predictors are most likely to predict correctly next year. For the institutional investor, that means fees on top of fees, as all of these experts charge handsomely for their services. And because we know it is not possible to systematically and reliably predict, these fees do nothing but reduce overall return.
In the individual investor realm, you only need to flip on CNBC for a few minutes to see how deeply entrenched prediction is. In almost every segment of the daylong broadcast you’ll see pundits boldly dispense plenty of reasons why the market is going to go up tomorrow. Or down. Or, more likely, both.
If you encounter an advisor who bases recommendations for your money on predictions of what is going to happen in coming weeks, months and years, I suggest you find another advisor.