As we begin a new year, investors are likely to be bombarded with predictions about what the year may hold for their portfolios. These outlooks are typically accompanied by recommended investment strategies and actions that are aimed at trying to avoid the next crisis or missing the next “great” opportunity. When faced with information of this sort, it would be wise to remember that investors are better served by focusing on their long-term plan rather than heeding to predictions and short-term calls.
Predictions and Portfolios
One does not typically see a forecast that says: “Capital markets are expected to continue to function normally.” Predictions about future price movements come in all shapes and sizes, but most of them tempt the investor into playing a game of outguessing the market. Examples might include: “We don’t like energy stocks in 2017,” or “We expect the interest rate environment to remain challenging in the coming year.” Bold predictions may pique interest, but their usefulness in an investment plan is less clear. Steve Forbes, the publisher of Forbes Magazine, once remarked, “You make more money selling advice than following it. It’s one of the things we count on in the magazine business—along with the short memory of our readers.”
Consider the probability problem acting on predications poses. An investor hears a prediction that equities are currently priced “too high,” and now is a better time to hold cash. If we say that the prediction has a 50% chance of being accurate (equities underperform cash over some period), does that mean the investor has a 50% chance of being better off? What is crucial to remember is that any market-timing decision is actually two decisions—getting out of the market and getting back in. If we assign a 50% probability of the investor getting each decision right, that would give them only a one-in-four chance of being better off overall. If we increase the chances of the investor being right to 70% for each decision, and the odds of them being better off are still shy of 50% — still no better than a coin flip.
The track record of professional money managers attempting to profit from active portfolio bets is poor and suggests active bets generally subtract value rather than add to portfolio returns. The table below shows Standard & Poor’s Index Vs. Active (SPIVA) Scorecard from midyear 2016, highlights how active fund managers have fared against a comparative S&P benchmark. The results illustrate that the majority of managers – after expenses – have underperformed over both short and longer horizons.
Percentage of US Equity Funds That Underperformed a Benchmark | ||||
| Fund Category | Index | One Year (%) | Five Year (%) | Ten Year (%) |
| US Large Cap | S&P 500 | 84.6% | 91.9% | 85.4% |
| US Mid Cap | S&P Midcap 400 | 87.9% | 87.9% | 91.2% |
| US Small Cap | S&P Smallcap 600 | 88.8% | 97.6% | 90.1% |
| Source: SPIVA US Scorecard, June 30, 2016. | ||||
Rather than relying on short-term forecasts that attempt to outguess market prices, investors can instead rely on the power of the market as an effective information-processing machine to set prices and on financial science to better structure investment portfolios. While realized returns may end up being different from expected returns, any such difference is generally unknowable and unpredictable in advance.
Conclusion
At the beginning of each year, it is natural to reflect on what has gone well last year and what one may want to improve upon this year. Within the context of an investment plan, it is important to remember that investors are likely better served by focusing on what they can control, such as maintaining a sound financial plan, investing to meet the goals identified in the plan, diversifying broadly, reducing investment costs, and minimizing taxes. Those who make changes to a long-term investment strategy based on short-term noise and predictions are likely to be disappointed by the outcome. So not only should you be wary of predictions in 2017, but be wary at all times.
Kevin Kroskey, CFP®, MBA is President of True Wealth Design, an independent registered investment advisory and wealth management firm specializing in retirement, tax, and investment planning. This article adapted with permission from Dimensional Fund Advisors. Kevin can be reached by calling (330)777-0688 or by email at kkroskey@truewealthdesign.com.
