I’m just joking around. Here is some of what Frank has to say about my favorite investing calculator in the whole wide world, the one that changes everything forevermore.
Juicy Excerpt: Taleb provides compelling evidence why the future cannot be predicted based on historical empirical observations. The reasoning is that the majority of that which impacts our world is the result of Black Swans which are inherently unpredictable…. When Rob runs his regression algorithms, he is not taking into account the billions of variables that had an effect on the markets in the past that may not exist in the future….
Frank is bringing something important to the table. Anyone who thinks that he or she can use the Return Predictor as his or her only source of investing guidance is a fool. That’s my take. And I think it would be fair to say that Frank agrees.
Where I part company with Frank is re his suggestion that someone who does not use the Predictor or some similar tool is not also a fool. I think that it would be just as much a mistake to fail to take into consideration how stocks have always performed in the past as it would be to consider only how stocks have always performed in the past. How stocks have always performed in the past is not the only thing that matters. But how stocks have always performed in the past does matter.
Is it possible that we will see something worse than what we have ever seen before? It is possible. But how likely is it? Black swan scenarios are by definition uncommon. They can turn up and people need to know that they can turn up. People need to consider the possibility of black swan scenarios in their planning. It makes all the sense in the world for someone to say “I am going to put a bit less into stocks than the Predictor indicates is wise because the data used to construct the Predictor covers a time in which there were no black swan events and yet these are a real possibility.”
What I don’t think makes sense is to be paralyzed by the possibility that a black swan scenario may turn up. It is true that this may happen. But what are we to do about it? What are the practical implications of an acceptance of the possibility of a black swan scenario? Are we to avoid stocks altogether? Is that a realistic way to go? I don’t see it.
Things would have to get pretty darn bad for us to see stocks perform worse than they ever have in the past. In the wake of the bull market of the 1920s, we saw a drop in stock prices of 89 percent. Anything less than that is something less than a black swan event, a possibility that is taken into consideration by those using the historical stock-return data as guidance re what may happen in the future. I don’t rule out the possibility that we could see something worse than that. I don’t let it paralyze me, however. I view the possibility of a black swan event as something that we just need to live with, like we live with the possibility that lightening might strike us dead someday.
The purpose of the Predictor is not to persuade people that black swan events will not turn up. It is to persuade people that, when they look to the historical data for guidance re how stocks may perform in the future, they should examine the data in analytically valid ways. We all consider what has happened in the past when investing, whether we acknowledge it or not. How can a stock investor not consider how stocks have always performed in the past? The point of the Return Predictor is to encourage people not to fall for the idea that always becomes popular when prices are where they are today, that this might be the first time in history when valuations will not affect future returns. The danger of falling for that one is a high-probability danger, one that has been causing the ruin of investors since the day the first stock market opened for business.
Please do consider the black swan possibilities. They are real. But please don’t get so worked up over black swan scenarios that you fall victim to the far greater risk that this will be the first time in history when following the Passive Investing model will work out in the long run. The historical data says it isn’t going to be that way. The smart bet is that things will probably turn out this time at least somewhat as they always have before.
Long shots sometimes come in. People are always amazed when they do but the reality is that from time to time they do. That said, it’s not a smart idea to bet all your retirement money on a long shot. You should be taking into consideration how stocks have always performed in the past when deciding how to invest today.
Today’s Passion: Felix Salmon, author of the Market Movers blog, said of the Predictor that: “For People Who Like to Take a 30,000-Foot View of Investing, This Is a Handy Little Tool.”