The pitfalls of market forecasting in the New Year

Bob Toomey |

Every year at this time, hordes of Wall Street strategists issue their prognostications for the performance of the financial markets in the coming year. They also opine on things like interest rates, inflation, and the economy. But is making these forecasts actually beneficial to one’s health or portfolio? Should one even pay attention to market forecasts?

There have been several academic studies of market forecasts published over the past five or so years. These include the Kaissar study, the University of Newcastle study, and the Bailey-Borwein study. Bottom line, these studies have shown that not only are the vast majority of forecasts inaccurate (Bailey-Borwein showed 48% accuracy across 6600 forecasts), they can actually have negative value because of the risk of investors straying from well developed plans. For professional money managers and planners, forecasts may have some value in helping to better define and understand key issues that could affect portfolio management. But in the end, market forecasting is not only difficult but also most of the time, wrong.

It turns out that there are a number of ways to improve your success in investing without relying on market forecasts. First of these is taking a long-term view. This means positioning one’s portfolio appropriately to meet long term objectives with the lowest volatility necessary and holding investments for the long term, meaning years. It means not trying to guess what happens in the “short-term” or trying to play short-term moves in the market as this has been shown to materially reduce long term portfolio returns. 

Having a sound financial plan is another way to improve one’s investment performance. This is because a comprehensive plan helps to better define a long-term financial roadmap and address uncertainties, and thereby establish an investment strategy that can be adhered to for the long-term with confidence and without anxiety about forecasts or market volatility.

Diversification is another way in which one can grow one’s portfolio while at the same time improving risk-adjusted returns. Diversification means holding investments in different sectors (asset classes) of the market such as stocks, bonds, real estate, and commodities. Holding multiple asset classes helps to reduce portfolio volatility while allowing the investor to maintain investments that help to achieve long-term financial goals.

The market has experienced elevated volatility over the past year, which is unnerving. With a well-positioned investment portfolio based on a sound financial plan, investors should not fear volatility or feel compelled to make a change based on someone’s market forecast. As the studies have shown, the odds are essentially a coin flip that the forecast is going to be correct. It is important to keep in mind the long-term performance of the stock market: large cap stocks have returned about 10% a year, on average, over the long-term. The stock market has recovered and gone on to new highs following every bear market. If one is confident in one’s portfolio strategy, there should be little need to concern oneself with market forecasts.

Robert Toomey, CFA/CFP, is Vice President of Research for S. R. Schill & Associates on Mercer Island.