Economics and finance involves a certain degree of forecasting by necessity. All of our portfolios with any directional bias involve implicit forecasts at a minimum. And any economic model we put together relies, to a certain degree, on our ability to understand the future outputs and their ramifications.
That said, we tend to be notoriously bad at forecasting. But that doesn’t mean we shouldn’t try to engage in it at all. Economists and market strategists stink at forecasting, but businesses and the general public still benefit from having even a general idea of what the world might look like in the future. A somewhat accurate forecast about the future is better than no forecast at all. For instance, when putting together a portfolio it’s generally safe to assume that stocks will rise over very long periods of time because human output tends to rise over very long periods of time. This is basically the essence of all buy and hold or indexing strategies. It’s a useful forecast in that it provides some high probability direction in the process of asset allocation. Will it always be right? Of course not, but it’s a better forecast than no forecast at all.
Of course, we would all benefit from being able to make higher probability predictions over the long-term as well as the short-term. After all, the financial and economic world isn’t just a “long-term”. It’s really more like a series of short-term within a long-term. So, what can investors and economists do to become better forecasters? This nice piece at Quartz highlighted a very good paper via the Journal of Experimental Psychology which highlights some of the traits of good forecasters:
- Being open-minded, thinking outside of your comfort zone and considering unorthodox views.
- Recognizing and avoiding biases.
- Training in probabilistic approaches
- Continually learning and updating your thinking.
Forecasting is never going to be a perfect endeavor. You will be wrong often in life in many of your predictions. That’s fine. But it doesn’t mean you can’t improve your odds of being right. Being open-minded, unbiased, probabilistic and continually updating your views are 4 pretty good steps towards making better decisions.