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Markets: Planning Over Predicting

Donald Calcagni

MBA, MST, CFP®, AIF®, Chief Investment Officer


Predicting the future is difficult – not even economists or the Fed can get it right. So where does that leave us? Instead of trying to predict the future or playing Powerball, we should plan for it.

CIO Perspective

Ah, the Powerball—that peculiar American tradition of buying the dream of a life without want. The jackpot recently hit more than $1 billion. A few friends and colleagues at the time jokingly asked whether they should allocate part of their portfolio to Powerball tickets; I sensed the inquiries becoming a bit more serious as the jackpot continued to rise to historic levels. But to win all or part of the jackpot, you need to be precisely right; there are no participation trophies in this game.


The folly of prediction

It’s perhaps ironic that the fields of economics and investing fail so spectacularly when it comes to the art of predicting. Rather than focus on directional accuracy—which requires a healthy dose of humility and an admission that our fancy models are almost always wrong or incomplete—the industry is hilariously fixated on precise predictions of inflation, GDP growth, interest rates, stock prices, and more.

Predicting the future is difficult. Consider inflation: Arguably no other economic metric is so exhaustively studied, yet not even the Federal Reserve—with every conceivable resource at its disposal—has any idea where inflation is headed. Fed chairman Jerome Powell recently quipped, “[W]e now understand how little we know about inflation.”1 And it’s not just the Fed. Professional economists routinely fail to predict inflation accurately (see chart below from The Grumpy Economist). John Cochrane, the blog’s author, goes so far as to suggest that professional economists are very good at being wrong (which he discusses in his new book introducing a theory about the causes of inflation)2.

Exhibit A: Economists seemingly aren’t very good at what they do.


Stock picking is hard

Let’s play a game. Go back to late 2009 … you’re a fund manager with Hot Shots ’R Us fund management company. Your job is to predict which stock will be the single best performer over the next 10 years. What would you recommend? Apple? Amazon? Definitely a tech company, right? No, coming out of the global financial crisis, you’d probably be a commodities bull, so perhaps you’d recommend a diversified basket of commodities.

Well, that would’ve been wrong because Domino’s Pizza was the best-performing stock for the period of 2010–2019. That’s right—a pizza shop bested them all by a mile (though being an Italian-American from Philadelphia, I object to referring to whatever Domino’s sells as “pizza”).3

Exhibit B: Apple or pizza?3

This failure in predicting extends to virtually all fund managers, most of whom are unable to outperform a simple index. If asset managers could accurately predict stock prices or market movements, you might surmise they could outperform a simple, passive benchmark. Yet over 85% of U.S. large-cap fund managers failed to outperform the S&P 500® Index in 2021. Over a 20-year period, the failure rate was 95.65%. Do you think fixed income managers do any better? Ninety-five percent of investment-grade intermediate bond funds underperformed the benchmark over 15 years (through December 2021).4


If you can’t beat them, join them: planning instead of predicting

Our mission is to help clients make the best financial decisions possible for the benefit of their families; it’s not to win some sort of winner-takes-all game show. Planning focuses on preparing clients and their portfolios for a wide range of possible outcomes—most of which are random and unforeseeable. Predicting, in contrast, bets the ranch on a very specific outcome—it seeks low-probability precision at the expense of high-probability directional accuracy. The former is predicated on hubris (e.g., overconfidence in how to pick a winning Powerball number or the next Domino’s Pizza), whereas the latter requires nothing more than a little humility and common sense (e.g., boring, low-cost, diversified portfolio with strategic tilts toward value and quality stocks).

Consider the Powerball, individual stocks, and blackjack. They can be quite entertaining, but only because each has low odds of success. To make matters worse, both the Powerball and blackjack have negative expected returns (if they were positive, lotteries wouldn’t work and casinos wouldn’t exist). And while stock in an individual company may have a positive expected return in the low single digits (about 4%), it’s far less than the expected return of its asset class (about 8%–9%).

Exhibit C: Which bell curve do you think is better? (Hint: It’s not green.) 5

Let’s think about this for a minute. If the expected return for a diversified U.S. large-cap stock portfolio is 8%, why would we invest in an individual stock that has an expected return of 4%? Answer: We wouldn’t, and we don’t. Rather than bet on some low-probability outcome (e.g., picking the next Amazon), it makes more sense to focus on building a broadly diversified portfolio than searching for the next Domino’s Pizza.

Exhibit D: Games of chance have negative expected returns and low odds of success (<50%). What’s worse, those odds deteriorate over time for an individual stock and for growth stocks as an asset class. In contrast, the market and value stocks have higher odds of success (>50%), and those odds increase with time.6

Strategy Odds of Winning Odds of Winning After 10 Years
Powerball 0.00000034% 0.00000034%
Individual Stocks 46% 19%
Blackjack 46% 46%
Russell 3000® 74.2% 97%
Value Stocks 59% 80%
Growth Stocks 41% 20%



Three things to remember:

First, predicting is hard. Even professional economists and fund managers fail to accurately predict inflation, GDP growth, and stock returns.

Second, rather than try to predict the future, it makes more sense to plan for it. Preparing clients—and their balance sheets—for a wide range of possible outcomes is far more prudent and effective than hoping for a specific outcome. Hope isn’t a strategy; planning is.

Third, investing doesn’t have to be hard. Investors can win by simply building low-cost, globally diversified portfolios that have strategic tilts to things like value and quality stocks. There’s no need to fret over picking the right stock, asset class, or Powerball number.

1 Jerome Powell, June 29, 2022
2 John Cochrane, “The Fiscal Theory of the Price Level”, 2022
3 Source: YCharts, Inc.
4 S&P Dow Jones SPIVA Report Card, 2021
5 Source: AllianceBernstein, “The Enviable Dilemma”
6 Percentages for stock and index returns complied from date from Source: Dimensional Fund Advisors and BlackRock

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