Why Stock Market Forecasting is Usually Worthless

Crystal BallKey Takeaways

  • Market forecasting or timing rarely works because no manager, no matter how well-credentialed or intelligent, can consistently predict the future.
  • Smart investors focus on the things they can control such as portfolio costs, diversification, staying fully invested and rebalancing as needed.
  • Even at 1 percent, the long-term cost of paying an active manager every year really adds up.

Even after all these years, the debate over “active” versus “passive” management continues to be a hot button issue in the financial services industry. The idea of stock market forecasting (i.e. market timing) is a concept on which conventional wisdom is based. This belief also just happens to be supported by several powerful industries (Wall Street and the financial media) worth trillions of dollars. Despite overwhelming academic research against the merits of market forecasting, and not to mention Nobel Prizes and mountains of evidence against the practice, the myth of market forecasting still persists. Forecasting is but one of several strategies that are considered “active management”.

Here at Independence Advisors LLC we take a values-oriented approach to our client’s financial picture that utilizes a proven strategy which is the polar opposite of market forecasting. It’s called “evidence-based-investing” and is a form of “passive management”. Whether it’s for an individual wealth management client, an endowment, a medical association or even a retirement plan, we have an unwavering commitment toward this academically-validated approach. And, if you look behind the scenes, you’ll see that the word “passive” is a misnomer and one of the great ironies of our industry.

The power of evidence

Using an evidence-based philosophy means that we let the evidence (i.e. research and hard facts) tell us which risks are worth taking for an investor. We don’t take risks that have no reward and we avoid areas of risk that we can’t control. Rather, we focus our efforts on things we can control such as portfolio costs, diversification, and discipline (staying fully invested and rebalancing as needed). We don’t try to speculate, gamble, pick individual stocks or time the market.

Market forecasting is usually worthless because no analyst, no matter how well-credentialed or intelligent, can consistently predict the future. That’s one thing I have found to be true above all else throughout my 24-year career in investments.

So why pay higher costs to an active manager for the hope of attempting to outguess the market? The research clearly shows that even when active managers guess correctly, it is very hard to differentiate statistically whether their correct forecast is due to luck or to skill. I would rather save that extra 1 percent annual management fee (or more) that I have to pay an active manager and instead compound it within my portfolio over the next 40 years. Assuming a $100,000 investment and a 7% annual return, saving 1% per year compounded for 40 years would leave you with an extra $148,886.

To learn more about the benefits of evidence-based investing, we have a fantastic set of four videos on the topic as well as informative white papers at our Evidence Based Investing Center. Have a question for the author? CLICK HERE TO ASK CHUCK

About Chas Boinske

Charles P. Boinske, CFA, is a 30 year investment management veteran overseeing the strategic direction and portfolio management process for Independence Advisors, LLC. Have a question for Charles? CLICK HERE TO ASK CHARLES

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