Editor’s note: Clients who are told to stay the course may still be tempted to disregard your advice. Here’s a piece you may want to share with them and encourage them to pass along to their adult children who are still DIY investors. Read another excerpt from Dan Solin’s book here.
“We find that none of the survey forecasts outperforms a simple random walk forecast, which predicts the future returns simply by their past sample mean.”
You turn on your favorite financial media channel. A distinguished-looking “expert” with impressive credentials discusses why their firm believes a particular company’s stock is poised for significant growth.
Their reasoning seems logical and compelling and their views credible.
Here’s the problem. They are emperors with no clothes.
They may be right or wrong about the stock. Tomorrow’s news will determine the future price, but a pundit doesn’t know what that will be. Relying on their musings offers you no better chance of picking a stock “winner” than a flip of a coin.
Your brain is tricking you into believing pundits have predictive powers.
The Forecasting Myth
Before delving into why your brain is predisposed to accept the views of pundits with no clothes, let’s examine the forecasting myth.
Pundits love to make predictions about the direction of the market, the future stock price of a company, where interest rates are headed, etc. Yet, their ability to predict the future is no greater than random chance.
A recent academic study by three professors from the John M. Olin Business School of Washington University in St. Louis analyzed three widely used survey forecasts to determine how well they predicted the stock market. These surveys included economists from industry and academic institutions, U.S. financial professionals and representative U.S. households.
The professional forecasters (which included highly trained economists) had a worse track record than the average household (you)!
In 2008, stocks fell 38.5%. Yet the median forecast from Wall Street “experts” predicted an 11.1% rise. The Wall Street consensus forecast was laughably wrong by 49.6 percentage points.
The Halo Effect
Accurate and reliable forecasting is a myth. Why do we believe in pundits with no clothes pretending to have expertise that doesn’t exist?
When someone appears confident, well-dressed, and authoritative, it creates a positive impression that spills over to their perceived expertise. We believe people with these traits have abilities they can’t substantiate (like the ability to predict future events).
This bias is called the Halo Effect.
It’s well documented that we assign positive traits (like generosity, intelligence and trustworthiness) to attractive people even though there’s no logical relationship between their appearance and those traits.
When we encounter people who match our mental image of experts, it impacts our brain and triggers the following reactions:
Reduced Critical Evaluation: We may be more inclined to trust and accept their opinions and expertise without critically evaluating their arguments or considering alternative viewpoints.
Enhanced Credibility: Their opinions and statements may carry more weight and credibility.
Increased Trust: We may experience increased trust and be more confident in their knowledge and abilities, influencing our decision-making and willingness to follow their advice.
Emotional Satisfaction: Encountering individuals who match our mental image of experts can provide emotional satisfaction and reassurance, contributing to confidence and comfort.
These impressions are based on our perception, which may be superficial and misleading.
Availability Heuristic
We tend to overweight current information, which can cause us to ignore other pertinent facts. This tendency is called the “availability heuristic.”
When an authoritative-looking “expert” urges us to change our investment portfolio, we may be inclined to make an emotional decision rather than calmly considering all relevant information.
Succeeding as a wealth management client or as a DIY investor requires one to overcome this bias and stay the course. Help clients understand the biases that may cause them to rely on the musings of pundits with no clothes.
Dan Solin coaches evidence-based financial advisors on how to convert more prospects into clients. His digital marketing firm is a leading provider of AI consulting, SEO, website design, branding, content marketing, and video production services to financial advisors worldwide. This excerpt is reprinted with his permission from his new book, “Wealthier, The Investing Field Guide for Millennials,” published in April 2024. The U.S. version is now available on Amazon in both English and Spanish, and a Canadian version will be published this fall.
