Do You Have "Prediction Addiction"?

"Prediction addiction" refers to events that are not predictable -- like the direction of the stock market or the future price of a particular stock or mutual fund.
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You are not alone. And it probably is not your fault. It may be chemical.

"Prediction addiction" was coined by Jason Zweig, a staff writer at Money magazine and the author of a fascinating new book, Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich (Simon & Schuster August 1, 2007).

It is the compulsive desire to try to make sense out of just about everything. Even events that are not predictable. Like the direction of the stock market or the future price of a particular stock or mutual fund.

This addiction is a particularly bad one. Not only are our brains hard-wired to believe we can predict the future and make sense out of random acts, it rewards us for doing so. The brain of someone engaged in this activity experiences the same kind of pleasure that drug addicts get from cocaine or gamblers experience when they enter a casino.

When predicting the unpredictable goes south, as it inevitably will, the neurons in the brain start misfiring, causing panic and anxiety.

Anything less than total confidence in our predictions implies that we have lost control. The brain resists this conclusion. Random events are perceived as the enemy.

Enter the broker. Many reinforce "prediction addiction" by validating the process. Stock picking, market timing, and picking hot mutual fund managers are premised on this ability to predict the unpredictable.

These brokers are to the investor what the drug dealer is to the addict or the casino is to the gambler. No wonder their allure is almost irresistible. Who cares that their much hyped prophetic skills do not exist?

Take a look at the comments on my blogs. They are filled with all kinds of predictions: stagnation, inflation, recession, depression, the further weakening of the dollar, the wisdom of investing in precious metals or foreign currency, the "inevitable" collapse of the domestic economy and of the stock markets. All expressed with great confidence.

The overwhelming evidence is that these events are simply not predictable.

Market timing is the most pernicious example of prediction addiction. We know we should invest in stocks when the markets go up and in cash, treasury bills or bonds when the market is going down. A huge industry is premised on its ability to make these predictions. However, the direction of the markets is not a predictable event.

In a classic study, Professors John Graham at the University of Utah and Campbell Harvey at Duke University analyzed the predictions of over 237 market timing investment newsletters for a 12 year period ending in 1992. By 1992, 94.5 percent of the newsletters had gone out of business.

The authors' conclusion: "There is no evidence that newsletters can time the market."

Benjamin Graham, the author of the investment classic, Security Analysis, and the financial genius who is credited with being the inspiration for Warren Buffet, put it this way:

If I have noticed anything over these 60 years on Wall Street, it is that people do not succeed in forecasting what's going to happen to the stock market.

Yet every day, investors get conned into engaging in this process, aided and abetted by their brokers, financial advisors and the financial media.

So, what's an investor to do?

Recognize the signs of "prediction addiction" and overcome it.

Pursue an investment strategy that does not depend on predicting the unpredictable. I set forth one such strategy in my blog: It's So Easy, Your Broker Could Do It.

Read any of the books written by John Bogle, Burton Malkiel, Larry Swedroe, Bill Bernstein, Mark Hebner, and my book, The Smartest Investment Book You'll Ever Read. While you are at it, pick up a copy of Jason Zweig's new book. It is an excellent read.

Think of us as your support group.

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