Why Do People Crave Predictions?

Investors looking to improve their decision making skills would do well to replace one (or all) of their financial news sources with Brian Burke’s advancednflstats.com. In a recent post, he writes:

“I once wrote to our own Carson Cistulli in an email that “People love lists and they love predictions. What I give them is lists of predictions.” Frankly, it wouldn’t matter how accurate the predictions are. People just crave them. The future creates anxiety, and whether accurate or not, predictions, help relieve it. At least, that’s what my astrologer tells me.”

He’s right. People crave predictions regardless of whether or not they provide any actual benefit. Burke has a simple, quantitatively driven model for predicting the outcome of football games that just happens to actually provide a benefit. It’s accuracy has been comparable to the average accuracy of the opening lines set by professional Las Vegas oddsmakers – they both get about 2/3 of their calls right.

CXO Advisory has been tracking the accuracy of stock market “gurus” for years. In contrast to the reasonable accuracy of Vegas line setters, the average accuracy of this list of more than 50 fund managers, academics, newsletter writers, columnists, and other market commentators currently stands at 47%, or slightly worse than random guesswork. This isn’t big news. What is surprising however, is how much this type of prognostication occupies the minds of investors, even after years of demonstrable futility.

My approach to portfolio management is built around creating an asymmetric return profile. Our efforts are directed toward limiting downside risk while leaving the upside unconstrained. It is a simple, quantitatively driven model that seeks a probabilistic edge. What we never do, is make market predictions. The interesting thing is that even long-time clients with great familiarity and comfort with the approach invariably ask for an opinion on the markets. They know what the answer will be, but it’s like having a missing limb. There seems to be some type of vestigial phantom impulse that leads us to seek relief from the anxiety of not knowing, even when it is well known that the intended source of relief has no ability to reliably deliver it.

If my own experience is any indication, fighting this impulse is a long, difficult process. However, the effort is worthwhile. Economic and market opinions that have a 50/50 shot of being correct are often worse than meaningless. We all know that most active managers underperform their benchmarks. What is less well known is that most investors dramatically underperform the funds they invest in. This is a well documented, long term effect of misinterpreting data and/or employing data that has been misinterpreted by someone else. It doesn’t really matter which, the net effect is obvious.

The first sentence of this post mentioned replacing sources of financial news with a website that uses statistics to analyze football strategy. That was actually serious. More market news, more analysis, more predictions are not the key to success. We can’t know the unknowable, but we can be better decision makers. Getting away from the din of aimless, vapid market noise is a step in the right direction.