Predictions Are Killing Your Returns

It's the season for predictions and the heavy hitters are out in full force. Their predictions are particularly dangerous because their credentials give them credibility. Unfortunately, investors are tempted to rely on their prognostications, often to their detriment.

David Rosenberg is a respected chief economist with Gluskin, Sheff & Associates. In 2012, he was named one of the five most influential Canadians in investing by Financial Post Magazine. He was the only economist recognized for his accurate economic projections in Fortune magazine's "Best and Worst of Wall Street 2011", and was ranked most accurate forecaster for 2011 by MSNBC.

Rosenberg is best known for predicting the bursting of the housing bubble in 2007. On the flip side, he also predicted the U.S. would experience a recession at the beginning of this year. That didn't happen. He is guardedly optimistic about the future, buoyed by the recovery in the housing markets and the fact that many other economists are more bearish. These contrary views have raised his "contrarian antenna." On June 18, 2010, he co-wrote a blog called: "An Intractable Fiscal Problem" in which he expressed a dim view of the U.S. economy, noting that the market was "still overvalued." According to Yahoo! Finance, on that date the S&P 500 index closed at 1,117.51. It closed on Dec. 14, 2012 at 1,413.58.

Sometimes his predictions are accurate. At other times, they are not. Your problem as an investor is that you have no way of knowing prospectively whether his latest prediction will be right or wrong.

If you choose to consider the forecasting skill of "experts", you should read an excellent white paper prepared by Vanguard, entitled: "Forecasting stock returns: What signals matter, and what do they say now?"

The authors reviewed a number of indicators typically used to forecast U.S. stock returns. They concluded that forecasting stock returns is "essentially impossible in the short term." Even over the long term, commonly used predictors "...have had little or no power in explaining the long-run equity return over inflation."

The ramifications of this well-researched analysis are profound. Much of the securities industry is premised on giving advice about the direction of the markets. Relying on this advice has very negative consequences. It distracts you from determining your capacity for risk, diversifying your portfolio, low fees and taxes. Of course, if you focused on these factors, you would quickly conclude that your interest is not served by using brokers or advisers who purport to be able to "beat the markets", using their predictive powers.

My prediction for 2013 is that, if you reach this conclusion and fundamentally change the way you invest, you will be investing responsibly and intelligently. You will also avoid becoming a victim of the securities industry.

Dan Solin is a senior vice president of Index Funds Advisors. He is a New York Times best selling author of the Smartest series of books. His latest book, 7 Steps to Save Your Financial Life Now: How to Defend Yourself Against Rigged Markets, Wall Street Greed, and the Threat of Financial Collapse, will be published on December 31, 2012. The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.