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Aren’t Bogleheads Predicting the Long Term?

I was intrigued by this question at the Bogleheads forum:

Aren’t bogleheads trying to predict the markets in the long run, there is an assumption/expectation that over the long run (30 years), the markets generally keep rising?

Yes. Yes. Yes. The forecasting approach used by Bogleheads is what economists call “Extrapolative Expectations”. In essence, it’s assuming the future will look something like the past.  So, using the Boglehead approach, you assume stocks/bonds will generate something close to their historical returns, reduce frictions, set it and forget it according to your risk tolerance.

Bogleheads and anyone else allocating assets has to be predicting the future. Some of them might not know it, might not understand it very well or might prefer to obfuscate about what they’re doing (usually a failed attempt to reinforce the illusion that they’re not being “active”), but they are absolutely, positively predicting the future. When you hear someone say that “forecasting is a fool’s errand” or that you should avoid prognosticators what they’re really saying is that short-term forecasts are stupid. For instance, anyone who says they know where the stock market will close in 24 hours, 7 days or next year is lying to you. As I have shown before, the markets become more predictable as we look further into the future. The financial markets are too random inside of these short periods to decipher accurately where they might end over these brief periods. BUT, we know, with a high probability, that the financial markets will tend to generate a positive real return over long periods of time because we know that humans will tend to innovate and become more productive over long periods of time. That, however, is a prediction, even if it’s a pretty safe one.

The problem, as I’ve explained before, is that the concept of the “long-term” is rather tricky for most of us. Our financial lives don’t really reflect a 100 year long-term or even a 30 year long-term. Our financial lives are more like a series of short-terms inside of a long-term. So, we necessarily have to make some short-term projections.  But here’s the kicker:

  • If you take a moderately long time horizon you can make reasonable projections about future outcomes.
  • If you take a moderately long time horizon you can reduce your taxes and fees substantially.
  • If you diversify your portfolio through index funds and ETFs you can insulate yourself from the short-term catastrophic outliers in the financial markets that hurt so many short-term undiversified investors.

So yes, we all make predictions. And that’s fine. Predicting the future doesn’t have to be a bad thing. It’s just a necessary part of asset allocation. The key is to avoid paying high fees/taxes in exchange for short-term predictions assuming that the prognosticator has some sort of crystal ball.