Among the many quotes people repeat from the mouth of Warren Buffett, one of my favorites is, “forecasts usually tell us more of the forecaster than of the future.”
This seems particularly important right now as the news and business television is filled with fears of a recession. Could a recession come this year? How deep of a recession will it be? Could we see a smooth landing by the Federal Reserve, to prevent such a pull back?
All of these forecasts do not tell us what will actually happen. In order to understand this, just look at the last recession that hit at the onset of COVID. How many forecasters had the US shutting down the economy to prevent a spread of an unknown virus?
Forecasting is essentially an economic analysis based on a variety of factors. It might include inflation, rates of manufacturing, unemployment and a myriad of other variables. But the weight that each variable has in the forecast will depend on the person running the forecast. The weights the analyst puts to each individual variable will depend on the psychology, fears, and needs of that individual.
Yet, much of that weighting based on the fears and psychology of the individual is unconscious. The person cannot recognize that they’re mudding the forecast with their own biases. Even if the forecaster knows this very fact, they cannot separate themselves from the forecast.
But here’s the bigger issue. Which forecasting reports do we then hear about? Negative ones, because they sound more sane and probable. When approached with a rosy picture of the future, we view it as if the person isn’t taking into account the downside. We believe they haven’t thought of recent trends that puts the positive spin at threat. In essence, we view it as naïve.
In the book Psychology of Money, author Morgan Housel summed this up perfectly. He describes what would happen if a Japanese forecaster in the midst of the Ally occupation following World War II gave an outlook that in less than 100 years, Japan’s economy would grow to 15 times the pre-war size. Or when Japan restricted food consumption for rationing to under 1800 calories a day, someone shouted from the rooftops that life expectancy will soon double. Or while few jobs could be found, Japan would go 40 years without unemployment that surpassed 6%. They not only would have been labeled a quack, but it could have led to physical harm.
We trust pessimism more than optimism. This pessimism bleeds into forecasts. But they’re often wrong.
Instead of forecasting, it’s more important to plan for what we know, and do our best to protect against what could happen. We don’t exactly know what will happen, but if we plan as if something bad might, we can protect for today and invest for tomorrow. This, over time, builds wealth.
How do we do that?
The more we save, the better we can predict that we will have funds available, even in times when uncertainty rises. If we have a high savings rate, it doesn’t matter if the market will go down a few percentage points this year or not.
Instead, we have money saved that will go down and go up with the market.
By investing in broad-based index funds, we capture the market no matter what it does. This protects us from pessimism, but also provides security when certain companies or sectors struggle – since struggles will persist.
If we have money in index funds, then we don’t have an investment manager pulling stocks out of technology companies on a whim. Or suggesting that bonds will always perform poorer than stocks. They don’t know the future, so this provides us the best protection you can when investing.
Finally, we build up an emergency fund. This gives us short-term cash to protect against most unknowns.
Does this mean that your investments will always rise? No. But will it protect you over many years, while also likely to grow your wealth in the meantime? As far as history can point us in the right direction, it’s far more useful than hearing someone’s opinion about where the market will be next year.