The Blog

A Foolproof Financial Outlook

There is hardly an industry that will pay so much attention to detail in preparing a yearly outlook as the world of finance; no, not a review of events and accomplishments, but a set of predictions.
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There is hardly an industry that will pay so much attention to detail in preparing a yearly outlook as the world of finance; no, not a review of events and accomplishments, but a set of predictions. For the most part, the objective is not so much to demonstrate the power of foresight, but to maximize profits by being able to "ride the next wave." In other words, to increase what the more fortunate already have -- money.

The pressing question is how good economic predictions are to begin with. One of my university professors never missed an opportunity to proclaim his view that "a bad model is better than none"; agreed, and yet possibly rather insufficient when making "bets" with real money. I cannot recall a single financial services firm that, with great conviction, rang the alarm bell before the market crash of the credit crisis. In fact, the Federal Reserve of New York even "came clean" in a 2011 blog entry, admitting "unusually large forecast errors," related to unemployment and real GDP predictions for 2008/2009. Even better is an extensive list of research on why so many economists failed to predict the Financial Crisis, with explanations ranging from systemic failure of the financial profession to conspiracy theories.

Aside from reviewing the predictive quality of economic forecasting, we can more broadly examine the common frame of mind and how we should receive input, not only from financial professionals. It should be clear by now that Wall Street firms are not necessarily incentivized to tell customers to "cash in," take a break, or wait for better opportunities. Instead, we are continuously "sold" somewhat good news. In addition, the internet and literature are full of guidance that positive thinking is better to begin with, and whoever dares to take a different perspective is considered uncool (I often find myself in this camp); this may be the reason why so many of us beat around the proverbial bush when asked to share a professional view. Just read Mr. Bernanke's 2008 testimony, "The Economic Outlook," covering the onset of the Financial Crisis -- it is masterful.

Now get ready for the twist. Not only have we come to understand that economic forecasting does not work, but, apparently, positive thinking related to our objective of achieving goals, does not work either. Instead, according to new research findings, the right dose of pessimism can be linked to better financial decision-making and (a nice added benefit) to staying healthier for longer. Those who tend to be defensively pessimistic will more likely invest in precautionary measures -- hardly a trait of optimists. Positive thinking about the outcome of goals can, in fact, hinder efficacy. Instead, the right dose of prospection (daydreaming) and mental contrasting will position us more optimally in identifying obstacles (or risks, when considering our investments).

Translating my findings into very personal financial affairs is next for contemplation. The bottom line, in my view, is to never disregard our common sense, including the perception of adverse outcomes. I have found that clients who are actively involved in planning and stating their financial objectives, paired with a critical view, will have better investment results. In this respect, it is not so important to simply "hit a number" linked to market outcomes, but rather to be grounded in realistic return expectations based on associated risks and impact on one's long-term financial goals.

As this is my first entry for 2015, in keeping-up with the prediction precedent of our financial industry, I feel obligated to attempt a "forecast" myself, but paired with the right balance of prospection and rational contrasting: My common sense tells me that, after years of the financial economy outperforming the real economy in the U.S., it is likely time for this relationship to revert towards an accelerating economy coupled with more moderate investment outcomes.