Predicting the markets

Have you ever dreamed about what it would be like to have the ability to foresee the future? Just think about the possibilities. Imagine if, on December 31st of every year, we knew what the best investment for the following year would be. We would be millionaires in no time at all!

Let’s say you invested one thousand dollars (one time) and succeeded in picking the best performing investment class every year since 1987. Today, you would have turned that $1000 into $700,000 dollars in just under 20 years. That translates to a whopping 39% compound average annual return.

Compare that to investing the $1000 into a diversified portfolio and your investment would have made an 8% compound average return over the same 20 years to give you an accumulated balance of $4,500. Now that’s a big difference – $700,000 or $4,500. All you have to do is to be able to predict the future consistently for 20 years.

The problem is this perfection does not exist in the real world. The reality is simple – there is no such thing as perfection in this industry. If there were, we would not need thousands of investments to choose from. George Hartman, the author of RISK is a Four Letter Word, said it best when he stated that investing is an inexact science: it is better to be approximately right than precisely wrong. As a result, I believe that rather than focusing on trying to find perfection, look to increase your probability of being right more often than being wrong and you will be leaps and bounds ahead of the pack.

Before we get into how to increase your probabilities, let’s take a look at Felicity’s friend Henry Hindsight. Henry was different because he did not possess the ability to foresee the future. Henry had to resort to strategies much more typical of the average investor. Henry always picked the best performing investment class from the previous year. I call Henry the trend follower.

Unfortunately for poor Henry, his investment strategy led him to poor investment choices. Over the past 50 years, chasing last year’s winners led to a loss approximately every other year. Henry’s dollar in 1900 is now a mere $783 – a far stretch from Felicity’s quintillions. As sad as this sounds, most investors think they can be Felicity Foresight but wind up being Henry Hindsight. The proof is in the fact that last year’s winners always attract the most money from new investment dollars.

To avoid this very common mistake consider some sound advice:

¨ Don’t Chase Last Years Winners – according to my research, last year’s winners have a less than 9.6% chance of repeating performance this year.

¨ Don’t Chase Last Years Losers – On the other side, don’t try to go the other direction because chasing last years losers increases your odds of picking this year’s winners to only 12%.

¨ Good Research leads to good decisions – Do your homework and look at investments from many different angles. Don’t just look at the past performance!

¨ Diversify – Don’t just pick one investment hoping that it is the big winner. Diversify your holdings to protect yourself from being the big loser.

¨ If it’s Too Good to Be True – Grouch Marx said it best! Remember that when it comes to investing, there is no such thing as perfection.

¨ You can’t time the market – Felicity could do it but no one else can!

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