Fix It Friday Ep. 6 - Beware Allowing the Illusion of Predictive Value to Influence Portfolio Decisions!

• Overestimating the reliability of our own or others’ predictions, particularly those of experts, often leads to poor decisions. The defining characteristic about the future is that there are no facts about it, making predictions inherently unreliable.
• Successful investors stick to long-term goals and plans, avoiding reactive changes based on short-term market performance, current events, or expert predictions. Adjusting portfolios should only happen when personal circumstances or goals change.
• Studies, such as those by Phil Tetlock, show that expert forecasts are correct about 49% of the time, akin to a coin flip. Moreover, the most famous or confident-sounding experts often have the least accurate predictions.

Disclaimer: [00:00:00] The following podcast by Fusion Family Wealth LLC, Fusion, is intended for general information purposes only. No portion of the podcast serves as the receipt of, or as a substitute for, personalized investment advice from Fusion or any other investment professional of your choosing. Please see additional important disclosure at the end of this podcast.

A copy of Fusion's current written disclosure brochure discussing our advisory [00:00:15] services and fees is available upon request or at www. fusionfamilywealth.com.

Voiceover: Welcome to the Crazy Wealthy Podcast with your host, Jonathan Blau. Whether you're just starting [00:00:30] out or are an experienced investor, join Jonathan as he seeks to illuminate and demystify the complexities of making consistently rational financial decisions under conditions of uncertainty. He'll chat with professionals from the [00:00:45] advice world, entrepreneurs, executives, to share fresh perspectives on making sound decisions that maximize your wealth.

And now, here's your host.

Jonathan Blau: Welcome to another [00:01:00] episode of Fix It Friday. This is Jonathan Blau, your host. Thanks again for joining us. Today I want to talk about a bias that that, that, that like all the other biases we talk about, causes us to make decisions that are not always in our best interest. And the good news about these [00:01:15] biases is they're systematic, meaning they occur regularly.

We can predict that they'll occur. So we can actually therefore learn how to fix them. And that's why we call it Fix It Fridays. So today's bias is called the illusion of predictive value. And what's interesting about that, at least to [00:01:30] me, I, I coined that phrase. I ha I haven't published it anywhere.

I haven't tried to get a trademark on it, but it's not a phrase that you'll see anywhere if you Google it, because it's something that I created. But what, what it refers to is the idea that we [00:01:45] overestimate. The reliability of our thoughts or the thoughts of an expert in being able to predict outcomes.

One example of, of the illusion of predictive value outside of believing our that what, what our [00:02:00] thoughts are will reflect the outcome. Outcomes. We may not have as much confidence in our thoughts. So we look to authorities. So, for example, in 2016, Paul Krugman, New York Times economist, wrote that right after Inauguration [00:02:15] Day, when Donald Trump is inaugurated, he predicted there's going to be a massive global recession and the stock markets would go down dramatically.

Somewhere south of 40%. And not only didn't his prediction hold true as to the actual outcome, but the first year following inauguration, the [00:02:30] stock market went up the most it had gone in a single year since about 1945. So it's important not to not to think that our thoughts or someone else's had any efficacy in predicting actual outcomes.

The outcomes very rarely will reflect anyone's thoughts because [00:02:45] there are no facts about the future. That's always the defining characteristic of the future. So what's interesting is, is that I have a story that I like to relate. It's, it's, it's regarding a client and and this particular bias that was impacting his potential [00:03:00] decision.

So around the time of March of 2020, when the global pandemic was, was rolling around in various iterations. The economy was shut down and we were all kind of hunkered down in our homes. This client called me up and in his business, [00:03:15] he's in the capacity of advising many successful entrepreneurs and business owners.

And he said to me, my feeling, Jonathan, is I want to sell out all my equities. And I said, what, what is it that caused you to have that feeling? And his response was what caused me to have the feeling is I have [00:03:30] some of the most successful entrepreneurs and business owners in many of the major industries they represent that our country does business in.

And they're telling me that this pandemic and what it's going to do to the economy is much worse than we could [00:03:45] ever anticipate. And they're on the front lines every day. And my response was to this person is that, look, I can't argue with them. They know much more about their businesses and they're on the front lines every day of the economy than you or I know.

I agree with you. What they have no idea about is what [00:04:00] their, their knowledge of those issues has to do with the economy. The future direction of stocks and the financial markets. They have no idea any more than you or I do. What I can tell you from history is that when we're down 34 percent in 33 days, which [00:04:15] is where we were basically at, at the time I had this conversation in March of 20 the markets have likely factored in all of this bad news and likely bad outcome.

And, and, and in my experience probably has already over factored it in relative to the long [00:04:30] term enduring values of the companies. Sure enough, thankfully the client did not sell out the portfolio. And the lesson that was learned is while the clients that he was referring to were right in terms of the economy, they shut for almost another eight months or so and, and the pandemic [00:04:45] continued to roll around the world and in various iterations for another year or so or longer.

What, what also happened is from the day of that conversation in March of 20 through the end of March of 20, so December 31st, rather of 20, [00:05:00] the stock market increased by about 65 percent while all of the bad economic and business events were, were unfolding. So so the lesson there is to to not try to marry what we think about a certain area that we have [00:05:15] expertise in to.

Outcomes in the financial markets and certainly not adjusting our portfolios in accordance with that. So one of the things that we, that we need to have as a takeaway is, and I'll say it again, because [00:05:30] it's worth saying, the defining characteristic about the future is there are no facts about it.

Don't assume someone will say it. Who's maybe better educated in a certain area that you're interested in learning about has more facts about the future or more efficacy predicting the future than you do. They don't [00:05:45] don't succumb to authority bias just because someone's an expert doesn't mean that their thought is a thought you should use in changing as it relates to your investment portfolio, your, your portfolio allocation.

And remember that our [00:06:00] experiences through life, each of us, represent, and I'm making this number up to make a point, 0. 00001 percent of everything that's ever happened in the world. But our experiences that I just described also account for [00:06:15] about 80 percent of how we think the world works. It's a very dangerous combination.

And so we're always acting on a very limited knowledge base when we make decisions about On these kinds of biases, when we make portfolio decisions, we should, we should only change our [00:06:30] portfolio under a couple of circumstances. That's when we have a major life change or when our goals or our plan change, and we should never change our portfolio in response to current events, short term market performance.

Geopolitical [00:06:45] crises or, or anything other than when our goals change and therefore our plan needs to change. And so the maxim that we use at Fusion to help clients become good long term investors is to say, [00:07:00] All successful investors, in our experience, are goal focused and planning driven. They build a portfolio that's married to their goals, and they stay to their plan, continuously, always.

All failed investors, in our [00:07:15] experience, are Performance driven and market focused. They, they react to almost every current event and change their portfolio in response to, to outside factors that have nothing to do with their longterm plan. And in my experience, those are [00:07:30] always failed investors. So it's important to always act on your plan and never react to current events and and market news.

One other tip I want to give you on, on experts and their forecast, there's a guy named Phil Tetlock who [00:07:45] produced a study that showed expert forecasters are correct about 49 percent of the time, and so it's the same efficacy of a coin toss. What he also found, which makes it worse, is that we follow the forecasters who are [00:08:00] either the most famous or the most corrupted.

Intelligent sounding, and those forecasters have had the worst forecast efficacy. So, it's important not to, not to put too much credence into expert forecasts. And finally, I want to [00:08:15] leave you with one of my favorite quotes that I think relates well to the illusion of predictive value, and it comes from Mark Twain.

And Mark Twain said, It ain't what you don't know. That gets us into trouble. It's what you know for [00:08:30] sure that just ain't so. So overconfidence leads us to to, to relying on our thoughts and thinking that they'll reflect the outcomes that, that we that we believe in and and they never have and never will.

So [00:08:45] with that, I, I thank you for joining us for another episode of Fix It Friday. Look forward to to, to being with you next time.

Voiceover: Thank you for tuning in to another [00:09:00] episode of the crazy wealthy podcast. For more insights, resources, and to sign up for our newsletter, visit crazywealthypodcast. com. Until then, stay crazy wealthy.[00:09:15]

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