The Dow just breached the 24,000 level. So where will it go from here? I predict the Dow will reach…1,000,000. And I’m very confident in that forecast. Let me explain.
One Million Methodology
Since mankind began tracking the stock markets, we have witnessed stocks averaging over 8% per year. Some people say future returns may be more muted. Perhaps. But so long as the average is positive, the Dow will reach one million. If the Dow were to achieve an 8% annual return going forward, then it would take 50 years to reach one million. If it earned 5% per year it would take 78 years, and if it only were able to eke out a 0.10% annual return, then it would take 3,733 years. But it would get there! And therein lies a significant problem with forecasts.
It’s Forecast Season!
As we end one year and begin another, it’s time for all the “smart” people to give us their predictions for what will happen. What is the historical accuracy rate of expert predictions? Depends on the study you look at, but most of them are around the 50% mark. Not too shabby…except you don’t know which forecast will be accurate until after the event.
When giving a forecast, not only does your forecast need to be right, but the timing needs to be right. What good is my forecast of Dow 1,000,000? The time period is too long for us to benefit from it. The good news is that you can never prove my forecast wrong because I never specified a time. A forecast without a specific period of time should be thrown out with the trash. Actually, with an accuracy rate of only 50%, you could make a case for throwing out all forecasts.
Illusion of Certainty
If we humans actually made decisions based on logic and reason, we would ignore expert forecasts. But because we are emotional beings, and make decisions largely based on how we feel, we are very much influenced by them. This is true in many aspects of life; we make a decision based on feeling and then seek out data to confirm that conclusion, while ignoring any contradicting evidence.
Our brain hates uncertainty. Because of that we are heavily influenced by the illusion of certainty. And the more confident the forecaster, the more likely we are to be influenced. We tend to throw out our skepticism whenever someone exudes confidence.
Investor Beware
Let’s understand our natural inclination is to be swayed by confident forecasts. We are also swayed by those who happen to get a forecast right in the past. Even a broken clock is correct twice a day. Our natural inclination, which is subconscious, is to listen to them. Great investors are able to override their natural inclinations by taking deliberate, purposeful steps to think things through logically. Easier said than done.
That is why a financial advisor or friend who understands the psychology of decision-making can be a great, in fact one of the best, resources an investor can have. Invest thoughtfully.
JAY