One of the sharpest minds in finance today belongs to Nassim Nicholas Taleb, professor of risk engineering at NYU-Poly. Taleb wrote an article in the recently published The World In 2013 which is the annual prediction-fest put out by The Economist Intelligence Unit. I think he makes some interesting points that can be useful to investors who are starting to think about how to position their portfolios for the coming year.
“Selling a precise prediction to an anxious investor is like offering water to a parched explorer lost in the Sahara.”
In his article, titled “From fat tails to Fat Tony,” Nassim Nicholas Taleb warns of the danger of making predictions about the economy and the stock market. Because these predictions are notoriously inaccurate, they often give us a false sense of certainty about the future. This, in turn, can cause us to make poor decisions about how to invest our money. From the article:
“The intrinsic limit to predictions is here to stay with us. It will not go away thanks to hard work by zealous researchers or more funding, more data, more computing power and more complicated theories. For unpredictability is part of any system that is prone to “fat tails,” that is, one whose properties are dominated by rare events – what I have called “black swans.”
The idea of black swans is central to Taleb’s thinking, and it influences almost everything he writes about and does as a trader. In his mind, the only thing about the stock market that can be predicted with certainty is that it will produce extreme events, and with more frequency, than most models predict.
“Predictions are good therapy, arising from a human thirst for certainty. That might have been reasonable in some ancient world, but is hardly right for today’s. The reason is that predictions lead to increased risk taking, hence to the accumulation of fragile exposures in the “tails.” Sensible discussion about the world in 2013 should therefore be based not on the predictive, but on the normative: what should happen.”
The truth is that we all crave certainty in our lives, and the stock market deplores uncertainty. This is not lost on the financial advice industry, and that is why every pundit, every talking head, every economist, financial expert, investment strategist, and everyone else who makes a living in the financial world has a prediction about what will happen in 2013. But how useful is this kind of professional stargazing? Taleb says, and I agree with him, that not only is predicting complex systems unrealistic, it’s actually counter-productive and downright dangerous.
A better approach to dealing with the anxiety about the future, and what to do with your investments, is to think about what your investing goals are. If you are a short term investor – meaning that you are less than 7 years from retirement – then common sense says you should not have high exposure to the stock market. But if you have a longer time horizon to work with, it makes sense to have a normal allocation to stocks. Nobody knows what will happen in 2013.
Since we don’t know what will happen, why should we assume the worst? Why not instead take a positive attitude and assume that the economy and the markets will behave in the same ‘normative” way that they have for the last 250 years? if they do, they will end the year higher than where they started.
My prediction for 2013 is that more damage will be done to your wealth by being too cautious than by being too optimistic. The media is hyping fear and loathing about the ‘fiscal cliff’ and other well-known risks to the economy. But is it wise to hide from the stock market just because something bad might happen? Are you going to wait until you are ‘certain’ that everything is o.k. before you get back into stocks again? If you do, the stock market will already be much, much higher than it is today.
My clients are fully invested in stocks right now, and until I see real signs of an approaching recession, I will continue to advise optimism and courage, rather than fear of uncertainty.
For more information on this, send a message to info@zeninvestor.org.
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