Financially Speaking Podcast

Our Propensity to Predict

Published on May 3, 2012

Why is it that we are so – gullible, fascinated, obsessed – with forecasts?  Jason Zweig writes in his book, Your Money and Your Brain:  How the New Science of Neuroeconomics Can Help Make You Rich, asserts that there is a human compulsion to make forecasts.  He calls it “prediction addition”.  It seems that humans are uniquely obsessive about recognizing patterns in random information.

We don’t have to be knowledgeable or educated in the areas we make predictions.  We just feel confident about making them, and we feel confident when we hear someone else make them.   Someone you know is probably pretty good at predicting the outcome of baseball game or other sports.  If he is right more than a third of the time, he – and you – have confidence in his ability to predict the future.  Eventually, both of you buy in to the idea that his predictions for anything – the stock market, politics, weather – is likely to happen.  Both of you become overconfident.

However, the consequences of acting on a prediction of a baseball score are very different from acting on your financial future.  Yet, many of us continue to act on financial predictions.

Take, for example, Harry S. Dent, Jr., a Harvard MBA who has written eight books on the economy and stock market.  His beliefs are based upon the predictable nature of consumer spending.  How anyone believes that consumer spending is predictable is beyond my understanding, but that is another story.  In 2006, Mr. Dent wrote that the Dow Jones Industrial Average would be 40,000 by 2010.  It was at about 6500 in March 2009.  In 2009, he advised listeners to get out of the stock market-just before the market recovered.  In his latest book, he predicted that the Dow would be 3000 by 2014.  The Dow is around 13,000 today.

People act on Harry Dent’s predictions, predictions that seem to be wrong most of the time.  When it is the wrong decision, it impacts your retirement nest egg.  But that is after you have bought Mr. Dent’s book.  I wonder if Mr. Dent acts on his own predictions.

The financial markets are permeated with uncertainty.  How can anyone make a reliable prediction which impacts your financial future?   Why do we sometimes act on those predictions?
 

Tags: stock market predictions

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