What if you accepted you couldn’t predict the future?

What if you accepted you couldn’t predict the future?

“Prediction Addiction” is dangerous to your wealth

In our Foundations’ series on Behavioural Science, we identified “Prediction Addiction” as a one of a number of psychological biases that are potentially dangerous to your wealth. We discussed there that:

“We have an in-built addiction to predict that is almost hardwired into our brains. Thousands of years of evolution have honed our biological need to detect and interpret patterns. We hate randomness and we have a compulsion to make predictions about the unpredictable. Our brains seek patterns automatically and most of the time this is occurring outside of our awareness.”

The financial media is full of often contradictory opinion on the future that panders to this instinctive desire: interest rates up, interest rates down, exchange rate up, exchange rate down, double dip recession, sharp recovery. The more extreme the forecast, the more attention it gets. It seems that one lucky correct extreme call can make a career!

Many forecasts prove to be spectacularly wrong and, often, very soon after the forecast is made. However, rarely, if ever, does that deter the forecaster nor does it appear to reduce their popularity or credibility (witness Associate Professor Steve Keen’s prediction in November 2008 that Australian property prices would fall by 40% over the next 12 months, or even the U.S. ratings agencies, with their flawed assessments of the credit quality of sub-prime mortgages).

There is a vast personal finance industry that has a strong vested interest in you believing that you know something about the future that market prices are not already reflecting. And, more importantly, you being prepared to put your “money where your mouth is”.

It doesn’t want you to know that the robust financial market research suggests that it is very difficult (if not impossible) to reliably outperform relevant market benchmarks e.g. the S&P ASX 200 for Australian shares. And that most apparent outperformance tends to be explained by luck or taking greater risk (often unwittingly) rather than due to either superior analytical or forecasting skill.

But giving up the “prediction addiction” is not easy. And, if you do accept that the constant urge to predict is not conducive to financial health then what you should focus on to give you the best chance of achieving the financial future you want.

Beating “Prediction Addiction” has social consequences

Admitting to both yourself and to others that your thoughts on the future may not be particularly insightful or original is not something that comes easily, particularly for males. To respond to a question such as “Do you think interest rates will go up?”or “Where do you think the exchange rate will be this time next year?” with “I have no idea” or “I have an opinion, but everything I know is almost certainly already reflected in market prices” sounds a bit wimpy.

An unwillingness to enthusiastically indulge in debate about such matters as the consequences of a downgrade in America’s credit rating for the US economy or the impact of a carbon price on the share market severely restricts the range of typical male dinner party conversation. You may find that you either have to find other topics of mutual interest or your dinner party invitations may start to decline!

An upside of beating the “prediction addiction”, however, is that you no longer need to be distracted by “the noise” created by the financial media. Time and money saved, together with reduced stress, are potential benefits. You can cancel that subscription to the “Financial Review”, unless you enjoy the gossip. Or stop religiously tuning into the nightly news explanations for today’s market moves, in the hope that they will give you insight regarding what will happen tomorrow.

And once you have really have the “prediction addiction” under control, you can choose to never listen to those finance “talking heads” again or, alternatively, be entertained by the absurdity of their self importance and irrelevance.

Focus on what you can control

But if you accept our view that it is potentially dangerous and misguided to build your financial future based on a need for successful forecasting, what should you focus on?

We think you should give all your attention to those things you can control or directly influence. With reference to your financial future, these include:

  • Human capital – this refers to building your personal value by concentrating on what your do best and/or enjoy the most;
  • Costs – you can directly control most of your cash outflows, including personal expenditure and investment costs;
  • Taxes – the tax impost on your affairs can be contained through careful structuring and planning ahead, and a focus on after-tax investment returns rather than headline pre-tax returns; and
  • Risk – although risk, particularly that associated with personal catastrophe and investment returns, cannot be completely eliminated, it should be managed consistent with your long term financial objectives.

While it is almost impossible to totally eliminate “prediction addiction”, a commitment to not let it influence decisions about your financial future is likely to prove both liberating and wealth enhancing.

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What if you accepted you couldn’t predict the future?

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