Why we are terrible at New Year's resolutions and forecasting
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Why we are terrible at New Year's resolutions and forecasting

Updated
2
Sep 2022
published
8
Jan 2021
Why we are terrible at predicting the markets

It's a losing game predicting the erratic behaviour of millions of market participants. We should bet on things we can control our own life choices.

The original version of this article first appeared in The Business Times.

As a new year begins, we make a new set of resolutions. Alcohol and cigarette sales drop and new gym memberships spike 30% to 50%, as people put those New Year's resolutions to work.

There is also another common feature. We see a deluge of forecasts and predictions pouring out of the financial media and the mouths of the "experts".

Investment strategists all over the world perform their annual practice of predicting where the market will head in the upcoming year. Full of confidence and bravado, they forecast whether it will go up or down, and where it will end up.

We are already hearing that 2021 will be a good year for cyclical stocks and value stocks, or that growth stocks are still the way to go. People expect the United States will continue to lead the way, or it is time for emerging markets or China, or that Singapore's Straits Times Index (STI) will rebound or continue to underperform.

Memories are short, and there is naturally little mention of the nearly universal failure to predict with any precision. Little surprise that none of the strategists look back at their past forecasts as another year passes and another forecast is paraded out.

It is a strange annual ritual that many people still follow and spend time on. Clearly, human beings are not known to have the ability to predict the future. We do not even know how long our New Year's resolutions will last. We often cannot control our own behaviour, let alone predict the behaviour of tens of millions of participants in the financial markets.

"Those who have knowledge, do not predict. Those who predict, do not have knowledge."
Lao Tzu, Chinese philosopher

A healthy dose of humility

Last year, no one predicted the 30% peak-to-trough fall in stock markets and the unprecedented disruptions in bond markets in March. They also did not expect markets to bounce back so quickly despite massive income and growth shortfalls across various economies. The MSCI global index closed the year with a gain of 14%.

Graph of global equity and fixed income markets from January to September 2020

It is safe to say that short-term predictions are fairly worthless, and paying attention to forecasts is a wasted effort.

As economist John Galbraith once put it, "There are two kinds of forecasters: those who don't know, and those who don't know they don't know."

With a healthy dose of humility, we need to admit that we all have little clue of where the markets will go over the next year.

Most of the time, strategists will just forecast a high single-digit return in any given year. This is because global stock markets have averaged 6% to 7% annual returns depending on currency and market. So these forecasts seem to make sense at first glance.

But this prediction is clearly meaningless if every single year the actual return is significantly higher than predicted, or negative. Returns have not only fallen outside the range every year, but they are also never at the long-term average.

What this means is that any short-term price movements over one, three or even five years are merely noise for the long-term investor. If you believe in the long-term economic progress of the world and realise that the equity markets are the selection of the best companies in the biggest economies, then you should understand that the market movements are actually noise (or short-term volatility to ride out).

Last year was a perfect example of how there has been much ado about nothing. It is better to remain invested through cycles, believing in the power of markets to generate average returns over the long term, than try to beat the market every year not knowing where you are headed.

chart of annual return of MSCI ACWI index from 1988 to 2020

Focusing on what works

Last year changed the landscape of investing and wealth in unforeseen and unpredictable ways. Millennial investors, with their Robinhood app, are gaining financial knowledge through social media, resulting in a marked uptick in trading stocks, passive index funds, and exchange-traded funds. These are all hallmarks of the digital-first disruptions that Covid-19 has brought about.

This generation has also laid waste to the so-called Wall Street experts and famous hedge-fund managers who have called the top of markets. We should all purge the charlatans of finance, who make bold — but mostly wrong — predictions about the future, from our reading list and podcast list.

Instead, we should focus on what matters and what works based on the science of investing and wealth, such as the power of markets and compounding, the benefits of diversification, and the importance of asset allocation.

We know we cannot predict the markets, but we can raise the probability of success if we focus on long-term returns. The power of compounding and time will do the bulk of the heavy lifting, without much effort on our part, if we remain patient with our money.

Our motto of wanting to make investing easier so we can live easier today and better tomorrow is fitting here. Long-term success can still be achieved without the hustle and bustle of daily stock trading or panic-driven activities in falling or rising markets.

It is common knowledge that too much activity and too much choice lead to poorer outcomes.

This past year has taught us that money is not everything and there are more important things in life — like health and family. But building wealth in the right way helps tide us through some difficult bumps along the way and enables us to pursue the more important things in life.

This year, we need to learn let go of what we cannot control — the market direction, the economy, or what will happen to Covid-19 — and focus on the only thing within our control — our behaviour.

So when you make those New Year's resolutions about your physical health — to give up smoking and alcohol, or to exercise more and eat less — do not forget to work on your financial health as well.

New Year's resolutions on investing at the start of the year also see a spike. However, this should be easier to sustain than going to the gym every week if we keep it simple by setting up some regular savings and investment plans.

Developing ongoing and good investing habits may be the most important thing we can do this year, and the only certain way to better prepare for a future that will always be uncertain.

To get started with Endowus, click here. Learn about dollar-cost averaging (DCA), and how it stacks up against lump-sum investing.

Next on the Endowus Fin.Lit Academy

Read the next article in the curriculum: How to start managing and investing your money (#adulting)

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