Why advisors should beware the fallacy of forecasts

Time is an investor's friend as strategist warns against letting downturns and analysts sway your thinking

Why advisors should beware the fallacy of forecasts

The wealth management industry is as guilty as any other for indulging analysts and “expert forecasters” to predict the future. Whether it’s sports broadcasters calling the Super Bowl or hockey pundits explaining why this is finally the Leaf's year, people’s crystal balls are notoriously cloudy, despite undoubted knowledge.

Steve Rogers, investment strategist at IG Wealth Management wrote about the “fallacy of forecasters” in a recent white paper titled Time in The Market, not Timing the Market, is What Builds Wealth, and told WP that the experts don’t actually know what’s going to happen.

He said: “Stock markets are volatile; you never know what is coming in the future. Nobody 12 months ago thought that COVID-19 was going to strike us with the severity that it did; you don't see these things coming.”

Just because Wall Street or Bay Street analysts put forward a consensus view that the S&P or the TSX will be up 5% 12 months out, Rogers urged investors not to put all their eggs in that basket. With the long-term market average going up, many analysts typically "play the odds". In the past 20 years, the consensus strategist S&P target has never been negative and yet six years have produced negative returns.

Rogers said: “Just like a decline doesn’t mean anything in terms of whether the year ends positive, just because an analyst thinks that 12 months out the market’s going to be up doesn't mean it's going to be up.

“There is not much value in that, especially when you could cynically say that’s the safe [option] for an analyst. If you don't know what's coming, then your best estimate is to go with the long-term average.”

If investors recognize that, historically, the market is usually up two-thirds of the time no matter what time period you're looking at, why fight those odds? “That’s the route to successful investing. Get a diversified portfolio and stick with it. Don’t try to get cute.”

The temptation to get cute is at its most alluring when there is a dramatic selloff, like in March. One of the graphs in Rogers' white paper detailed how over the past 40 years, the average year had three downturns of 5% or more, while the average year had one downturn of at least 10%. All in, the average year has had a downturn of at least 14%. These instances are where investors start to panic and call their advisors.

Rogers said: “Those types of downturns are not uncommon; they are to be expected and are frequent. It's the way that people react to them that really determines how their investment strategy is going to work over the long term.

If you panic and get out, chances are you're going to miss out on significant events because it’s well documented that the disproportionate returns tend to occur in the early stages of recovery. If you sell, you're probably going to miss the bounce.”

There is also no correlation between the frequency or size of the downturn and what the year on a calendar basis actually ends up doing. Rogers added: “2020 was a good example of that. Nobody in the midst of a 37% downturn might have guessed that we would end up with an above-average year.”