Topic: How To Invest

Relying on investment forecasting will likely cost you money—here’s why

economic forecasting

Investment forecasting—especially when part of a sales pitch—is just one example of how conflicts of interest can hurt you

The investment business is riddled with conflicts of interest. These conflicts have a way of tainting investment forecasting so that they agree with and support sales pitches. Your best defense against this arrangement is to maintain a healthy sense of skepticism.

You should feel free to examine and question the basis for a prediction. You need to keep in mind that many predictions make superficial sense. They go wrong by misinterpreting facts, or leaving them out of the discussion altogether.


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“Peak oil” is a great example of investment forecasting gone wrong

In particular, you should treat economic predictions with a larger-than average dose of skepticism. Economic forecasts attract far more media and investor attention than they deserve—way out of proportion to their value in guiding your investment decisions. That’s true at all times, but especially today.

Accurate investment forecasting is rare. There are simply too many economic variables that can have an impact, and they can interact in too many different ways. Each of these factors, and every interaction that takes place amongst them, is subject to a random element. That’s why nobody guesses right every time about next year’s economic performance, much less next year’s stock-market performance. Even the best-known and most highly respected economists and analysts can be half-right one year, and way off the next.

The best example so far this century took place in the oil market. After oil prices got up above $145 a barrel in 2008, many prominent economists predicted that fast growth in India, China and other emerging economies practically guaranteed that oil prices would keep rising indefinitely. Common predictions had oil rising to $200 a barrel, then moving higher still.

In the depths of recession the following year, however, the price of oil plunged to $30.

Some oil alarmists stuck to their investment forecasting. (They defended it with a claim you’ll often hear when predictions fail: “I wasn’t wrong, just early.”) When oil got back up into the $80 to $115 range between 2011 and 2014, predictions of $200 oil got even more common. But it turned out that oil alarmists were putting far too much faith in “Peak Oil,” otherwise known as Hubbert peak theory. This theory rests on the belief that oil production would soon reach a predictable peak and tail off, while oil demand continued to rise.

The Peak Oil Theory made superficial sense. However, it failed miserably in sizing up the oil market, for two reasons. First, it neglected to take account of technological progress in oil production, particularly in the growth potential of shale oil production. Second, it failed to recognize another source of progress: Rising prices also spur innovation on the demand side—as oil prices rise, oil users work to increase the energy-generated-per-barrel of oil.

In mid-decade, many investors, analysts and media commentators treated $200 oil as a near-certainty, if not an article of faith, and encouraged followers to do the same. Instead of heading for $200, however, oil dropped from $110 in mid-2014 to $28 in 2016. It rebounded to $77 in 2018 but dropped to $45 by December that year. It then moved sideways between $50 and $70 in 2019. It hit a peak of $65 this past January, then plunged to $10 a barrel in April. Now it’s back up above $40…but I don’t hear any predictions that it’s on its way to $200.

If you let faith in a prediction play a role in your investment decisions, you can expose yourself to a lot of extra risk. The $200 oil prediction might have tempted you to load up on junior and penny oil stocks, for instance. (They’ve been disastrous performers, as you’d expect.) You’re far better off to recognize the value of diversification and avoid the risk that comes with acting on predictions.

I don’t know of any common prediction today that comes with the catchiness of “$200 oil.” However, a lot of investors today seem to be saying that they “…can’t understand how the market has been so strong in light of the long, deep recession we are obviously in.”

For the moment, let’s just say that if you follow our advice about stock selection and portfolio-building, and if you can afford to stay in the market for several years or longer, now is still a good time to buy.

Relying on investment forecasting will likely cost you money

When investors base buy and sell decisions on a short-term stock market forecast, they often experience notably poor investment results, or even lose money. This may come as a shock to them—that their predictions didn’t come true. It may have seemed to them that market trends, up or down, are easy to foresee. But in fact, nobody consistently foresees these trends. That’s why most investors hurt their returns if they let short-term stock market forecasts have much of an impact on their investment decisions.

That’s despite the fact that many investors may have guessed right about a coming trend at one time or another. Maybe they bought just prior to a big upswing, or sold in advance of a major slump. In the long run, however, these experiences may wind up costing them money. They may bet twice as heavily on the next trend they foresee, with more volatile stocks, only to discover their forecast was 100% wrong.

Use our three-part Successful Investor approach rather than forecasting to guide your investment decisions

  1. Hold high-quality, mostly dividend-paying stocks.
  2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
  3. Downplay or stay out of stocks in the broker/media limelight.

How much trust do you put in investment forecasting?

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