Bold, confident and wrong … on forecasting and expertise

We wrote a full chapter on forecasting and expertise. It is human tendency to seek the knowledge of the future. It is good to know what can happen, but trying to find out exactly what would happen and exactly when is nothing short of day-dreaming.

Read the following article:

Bold, Confident and WRONG: Why You Should Ignore Expert Forecasts

In the context of investing, this is the biggest game being played – prediction of the market values. It is amazing how the game continues for so long in spite of the poor record of the forecasters.

It proves the popular saying wrong – “You can fool all of the people some of the time and some of the people all of the time, but you cannot fool all of the people all of the time.” Somehow the forecasters in the markets have been able to continue the game for so long. It is amazing that the tendency to know and profit from future is so strong that we ignore the track record of the forecasters.

So what do you do if you don’t know the future? Peter Bernstein’s line in the referred article says it all.

“That’s what diversification is for. It’s an explicit recognition of ignorance.” – Peter Bernstein

That’s it. Just stay diversified. It’s the best defence available for those who understand that they are ignorant.

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The world’s smartest investors have failed …

Time and again, we see a phenomenon recurring. Experts fail to live up to what they promised. It only goes to prove that while these people are smarter than many others, the combined intelligence of the markets remains unbeatable for long. Read this post by Motley Fool:

The World’s Smartest Investors Have Failed: The poor performance of hedge funds

In the book “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget”, we have mentioned many such anecdotes when either the experts failed to deliver on their promises or they failed to beat the market or both.

The truth is: There are no experts, only varying degrees of ignorance.

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Financial illiteracy and overconfidence

“Mixing a decline of financial literacy with an increase in self-confidence is a toxic combination,” said John Howe, professor and chair of the Department of Finance in the Trulaske College of Business.

Essentially, the big problems that majority of people do not understand are:

  1. Ignorance about one’s own ignorance. We are often not aware of what we do not know.
  2. Assuming that expertise is fungible. It is assumed that expertise in one area is equivalent to expertise in another area – especially “management of personal finances”

Expertise or success in one area makes one confident and sometimes overconfident. Add a dose of ignorance to that and one does not even acknowledge that one could be ignorant in management of money.

Professor Howe further continues, “This opens the door for more honest mistakes as well as fraud. It’s widely known that older adults are very common victims of financial fraud. It’s important that as we age, we find someone who has our best interests in mind when managing our finances.”

Important to recognise our own inability, our own limitation and seek professional help.

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Knowledge and expertise are not fungible

“All of them were clearly intelligent and knowledgeable about a great many things – as long as those things had nothing to do with their money.


Most of them simply didn’t understand the principles of investing.”

Liz Davidson, Founder and CEO of Financial Finesse writes in the book “What Your Financial Advisor Isn’t Telling You – The 10 essential truths you need to know about your money”

Financial Finesse is a sort of a helpline in the US for people to get guidance on their personal finance matters. The above lines talk about the behaviour and attitude of generally intelligent and successful people. These are educated and intelligent people, successful in their respective fields of work. However, that expertise and knowledge are not fungible. Expertise in one area may not mean expertise with money.

In the absence of proper knowledge one is unable to understand or see the risks properly. Half knowledge can sometimes be dangerous. As we know from the Mahabharata, it was half knowledge that actually killed Abhimanyu.

As with Abhimanyu, who could not get out of the seventh chakra of the chakravyuh due to insufficient knowledge, many investors have painfully found that it is easy to get in an investment, but it is most difficult to get out of it, if one does not know enough.

Be careful with your investment. If required, take professional help.

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The need for diversification

Why do we need to diversify?

Well, very often, people look at the performance of a diversified portfolio and compare it to one part of it. And obviously, at any point of time, the portfolio is going to underperform at least one part of itself – if it is diversified well enough. What gets discussed in public including media and what draws everyone’s attention is the winners – be it in real life or in investment markets.

However, this knowledge is available always in hindsight – after the event is over and not before. By the time someone acts on this knowledge, the gains are gone already and one ends up buying the investment at a high cost.

Many investors know that they are not the experts and hence they seek expert advice assuming that advice is equivalent to the ability to forecast. However, it is important to remember that “there are no experts, only varying degrees of expertise.” The track record of experts even in their field is very discouraging when it comes to prediction about the future. They are not even consistently wrong, just erratic.

If that is the case, what should one do?

“That’s what diversification is for. It’s an explicit recognition of ignorance.” – Peter Bernstein

Diversification is not just a recognition of ignorance, it is also a shield against one’s ignorance and stupidity.

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Market crash or reputation crash?

If you want to see what market booms and busts can do to one’s reputation, Professor Irving Fisher’s statement in October 1929 would be a most appropriate example

Read more in the book “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget”

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Tomorrow never comes …

There are many small stories in the epic Mahabharata. In one such story, a beggar comes to the Pandavas asking for some help. They are in the midst of a discussion, and Yudhisthira, the elder brother, asks the person to come the next day. Hearing this, his younger sibling, Bheema reminds Yudhisthira of the audacity of assuming that he would be alive tomorrow. This story highlights the importance of understanding uncertainty associated with the future.

However, we have always wanted to know the future.

Often, the experts get swayed by the same emotions and get their forecasts wrong.

To read more “On Forecasting and Expertise”, see the book “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget”

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