Do you think stocks will increase this year, and if so, by how much? Where do you think the real estate market is headed? Do you have a feeling about where bond rates will go?
It’s tough to predict the future of the economy, or the future performance of any asset, even if you’re an expert in the subject. Most of us have learned to embrace uncertainty and risk as a central and crucial aspect of the investing world, but why does it exist? Why is the investing world so unpredictable? And can we find a steady, predictable path amidst the chaos?
Our Collective Craving for Stability and Predictability
Wouldn’t it be nice if you could perfectly predict the right time to sell your house? Or the best time to buy a new stock you’ve been eyeing? Of course, it would. All of us, to some extent, crave stability and predictability. We want a world of order, sense, and reason. And because we want to live financially stable lives, we crave order, sense, and reason even more in our financial decisions. Without predictability or stability, every investment decision is a kind of gamble.
Thankfully, despite our unpredictable economic order, there are some strategies and tactics that can give you a smoother, more even experience.
Why the Investing World Is So Unpredictable
First, why is the investing world so unpredictable?
There are several explanations:
- The inherent unpredictability of the future. We’re not nearly as good at predicting the future as we like to think – and Black Swan theory attempts to explain the why’s and hows. As human beings, we notoriously overestimate our knowledge about the world and our ability to predict future events, and large, unpredicted, “outlier” events are perfect examples of this. For the most part, economists didn’t predict the 2008 financial crisis, even though it’s easy to see the root causes in retrospect. When we’re in the middle of an era, it’s hard to have the perspective necessary to see how our present variables could influence the future; the future is inherently unpredictable. And if the future is generally unpredictable, what hope do we have to predict how financial assets will perform in that future?
- Economic complexity and hidden variables. Economic interactions are extraordinarily complex, especially at scale. Housing prices don’t rise just because of one variable, like a lower interest rate; they rise because of many variables, like interest rates, inflation, loan availability, consumer sentiment, geographic demand, the political landscape, and more. Also, all these variables are just ones we are aware of; economic environments are also influenced by “hidden” variables that are harder to identify or understand.
- Bad and misleading data. It doesn’t help that economists sometimes work with bad or misleading data. As an example, the consumer price index (CPI) is no longer a reliable tool for apples-to-apples comparisons since the items in the index have been changed.
- The limitations of historical data. Even if our data were perfect, we wouldn’t be able to predict the future with perfect accuracy. While historical data can help us understand trends in retrospect, it’s limited in its ability to tell us what’s going to happen next.
- Democratized information and complex interactions. The democratization of information leads to even further complexity. You may have a piece of information about how a particular asset might perform in the future, but so does every other investor; the actions of these other investors, in response to the information, can change the outcome. For example, if millions of people buy an asset expected to perform well, the asset may outperform initial expectations.
- Flawed and contrarian experts. Economic experts are often divided into financial topics; there’s rarely a clear consensus to work from.
Finding a Steady Path
There’s nothing you can do to make the investing world predictable or consistent, but you can find a consistent, steady path for your own financial growth. The key is to incorporate reasonable, rational strategies that you can execute on a consistent basis, regardless of what happens around you. Dollar cost averaging (DCA), as an example, encourages you to buy fractional shares of a new asset at regular intervals, such as buying 10 shares of stock on the first of each month, regardless of what happens in the stock market. If you do this consistently, you’ll buy at both high times and low times, ultimately evening out your point of entry and stabilizing your future returns. Portfolio diversification is another similar way to stabilize your returns.
We may not be able to predict the future of the economy, and we may not have the tools necessary to chart the future performance of any given asset. But we do have enough sense to realize that investing is unpredictable – and enough strategies to help us balance things out.