Activity Idea: The Problem With Investing Predictions
Here’s a fun activity to show your students the value of stock market predictions (hint: they are not very valuable!)
After an almost uninterrupted climb upwards for five years, the stock market has stumbled recently. This chart of the S&P500 index captures the extent and persistence of this climb:
So, after bottoming at about 660 in 2009, the S&P500 has risen to recent levels approaching 2000 for a 200%+ return. In other words, if you had invested $1,000 early in 20009, the value of your investment would be close to $3,000. Stock prices don’t go up forever though and so commentators are keen to try and predict when they will turn down (so they can claim they are prescient despite the fact that most commentators have predicted 10 of the last 2 downturns). So, with the S&P500 down almost 5% from its peak in September, the hyperventilating has picked up recently.
Here’s an interesting 15 minute activity for students: go online and find five stock market predictions from the so-called experts (videos might be useful as it will give you an idea of the confidence these experts have). Have the students summarize their predictions and find evidence of their credibility as to why you should heed their advice.
Here’s a smattering of recent headlines that I uncovered:
- As storm clouds gather; forecast isn’t calling for correction (yet) (CNBC)
- Warning: Stocks Will Collapse by 50% (MoneyNews)
- Will the stock market finish the year with a crash or a bang (Daily Finance)
- Is this a “head for the hills” moment for investors (CNBC)?
So, here is the basic problem with predictions: they are usually wrong. However, as humans we are wired to create order out of chaos or certainty from uncertain conditions. So, when an expert comes on CNBC or is quoted in the Wall Street Journal, we unfortunately are prone to listen to them because we are in search of answers. Late in a bull market, when stock prices have risen unabated for so long, the number of experts who have been “right” about stocks rises exponentially too. In fact just this week, a friend told me that Bank of America was a buy because a co-worker said it would double in the next few years. When asked for details, he said his friend had made money on the stock and therefore his prediction had value. This blog post from Big Picture Blog sums up the value of pundit (or other so-called experts) forecasts as “wildly unsupported speculation:”
Unfortunately, investors all too often give these “predictions” in print or on TV far more weight than they should. It’s very easy for a confident-sounding analyst, fund manager or professor to say something on TV that can throw off the best laid plans of investors. I wish an SEC-mandated disclosure accompanied all pundit forecasts: “The undersigned states that he has no idea what’s going to happen in the future, and hereby declares that this prediction is merely a wildly unsupported speculation.”
So, what’s the lesson for students:
- The future is unknowable so ignore the forecasts that investing gurus put out there with such certainty. This is particularly true when the stock market is undergoing a downturn as the headlines will scare most people out of their wits. Why is this bad? Once people sell to get out of the stock market, they often have trouble getting back in. Only need to look back at 2009 and anyone who sold then and didn’t get back in has regrets as they missed the 200% return since then.
- Have an investing plan and stick to it. For an early investor, it may make sense to invest a fixed amount every month (called dollar cost averaging) into a few index funds (domestic stock, international stock and total bond index) that provide a diversified basket of stocks. By buying consistently over time, you are buying more shares when prices are low and less shares when prices are high which smoothes out an investor’s returns vs. trying to “time the market” and buy at the optimal time.
- Mentally prepare yourself as a downturn in the market is inevitable after the recent climb. Here’s some sage advice from WSJ columnist Jonathan Clements which includes mentally preparing for a situation that may or may not come (remember Howard Marks interview in which he discussed how emotions are an investors worst enemy):
“Meanwhile, the second question should be considered by anybody who owns stocks. Let’s say you have $200,000 invested in shares and the market tumbles 25%. The percentage decline might not seem so terrible, but consider what it means in dollar terms. How would you feel about losing $50,000?”
- Avoid placing much stock (no pun intended) in the hyperventilating gurus as their businesses often rely on investors actively trading their portfolios.
About the Author
Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.