The folly of forecasting stock market returns
People love to make predictions, especially when it comes to forecasting stock market returns. We believe that accurate forecasting is practically impossible, and, even when a prediction turns out to be accurate, it is hard to say whether it was the result of luck or skill.
How do we approach forecasting stock market returns?
Rather than relying on predictions for our investment strategy, as many people do, we make assumptions based on decades of evidence from market data and academic analysis. We assume that:
- Capitalism will remain the world’s preeminent economic model and will continue to provide a steady return to those invested in it.
- On average, certain types of security will perform better than others over time, so it is worthwhile focusing on those in a portfolio.
- Holding a high number of securities will help manage risk and increase the reliability of investment returns.
You could argue that these statements are predictions themselves because they relate to future events. But which would you rather have form the basis of your investment strategy? These three statements—or, as is the case with many conventional investment strategies, the changing guidance of a small group of investment insiders (or so-called experts)?
Plan for the things you can influence
Some forecasts, however, are worth making in relation to your financial planning – generally those over which you have a degree of influence. For instance, when you plan to retire and how much money you will need to meet your future financial commitments. Sensible judgements like these are key to forming an effective financial plan.
Making fun forecasts about sports results or speculating about the direction of the Pound or the fate of the eurozone is one thing. Basing an investment strategy on them is something else altogether.
Original Source for this article – Dimensional Fund Advisers