Do “Experts” Deserve to be Punished?

Can we believe what the “experts” predict?

Did anyone predict that the cost of a barrel of oil would drop to below $0 just two years ago? That from 2021 to 2022 inflation would grow to 8+%? That butter—delicious, bread spreading and lobster dipping butter—would increase in price by 25%?

Once again, a certain cast of characters failed to predict these things. We call them: “the experts.” From oil prices to inflation (it was supposed to be “transitory”), expert economists fail us again and again.  Perhaps the late American humorist Evan Esar said it best: “An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today.”

Man cannot predict what will happen for one simple reason: people. Yet Modern Portfolio Theory (MPT), the theory upon which current investment planning largely rests, says that all people are “rational” (based on the work of Merton Miller and Franco Modigilani in 1961). In addition, MPT assumes markets are efficient – meaning at any given time, a stock’s share price in the market incorporates and reflects all relevant information about that stock.

Most Americans, whether they are aware of it or not, rely on MPT to help fund their retirement through Systematic Withdrawal Plans (SWPs). SWPs mean selling a chunk of your portfolio each year to meet your income needs. SWPs are popular because Modern Portfolio Theory reasons that if, on average, a portfolio can gain X percent, then we can sell Y percent per-year to meet a retiree’s income needs.

There are two fundamental problems with Systematic Withdrawal thinking based on the assumptions of Modern Portfolio Theory. The first is that MPT assumes that humans are “rational.” I think both you and I know a few people who are less than “rational” when it comes to decision making — especially when it comes to the timing of their financial decisions. This is understandable since people are subjective, not objective, when it comes to decision making about themselves (in reality, people are “normal”).

The second problem is that MPT assumes that markets are efficient – again, indicating that at any given time, a stock’s share price in the market incorporates and reflects all relevant information about that stock. If the markets were efficient, the market crash of 1987, or the credit-default swap crisis of 2008 theoretically never should have happened.

Now, let’s think about things slightly differently. Let’s view people as “normal” and markets as inefficient. When we do this, we start to see why “top-down” all-encompassing predictions can be wrong. People often make decisions based on emotions, rather than rational logic, because people are normal. And markets, and life, are full of Black Swans events, these consequential rare events that turn the tides of history and for which we need to be prepared.

Predictions depend on the hubris of man. As we have mentioned in our Insights blog before: when man tries to predict the future, he eventually, inevitably, gets it wrong. Rather than rely on the predictions of “top-down” thinking, consider “bottom-up” thinking. Analyze companies rather than global economies. Look for solid companies with long track records and clean balance sheets.

 After all, prediction and explanation are exactly symmetrical. Explanations are, in essence, predictions about what has happened; predictions are explanations about what is going to happen.

 

DISCLOSURES

The information given herein is taken from sources that IFP Advisors, LLC, dba Independent Financial Partners (IFP), IFP Securities LLC, dba Independent Financial Partners (IFP), and its advisors believe to be reliable, but it is not guaranteed by us as to accuracy or completeness. This is for informational purposes only and in no event should be construed as an offer to sell or solicitation of an offer to buy any securities or products. Please consult your tax and/or legal advisor before implementing any tax and/or legal related strategies mentioned in this publication as IFP does not provide tax and/or legal advice. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation, or needs of individual investors. This report may not be reproduced, distributed, or published by any person for any purpose without IFP’s express prior written consent.