Professional Pilots have an amazing way of setting aside their emotions while flying an aircraft, especially below 10,000 feet. During the critical phases of flight, they can completely follow procedure using pure logic and systematization. Let’s face it, we don’t really have a choice—for our passenger’s sake and our own.
Flying is a science and therefore predictable. Our knowledge of the condition of the aircraft, airspace system, and weather are the primary variables dictating a positive outcome for each flight. We arm ourselves with great knowledge about these variables as well as hone our flying skills, before flying the line, to tackle any anomalies involving these variables to ensure a safe landing at the end of each flight.
So why can we not apply similar types of techniques to our retirement plans, much in the same way we plan for each flight? If we could just figure out the science behind the markets, we should be able to predict the outcome of our portfolios, right? After all, if you watch CNBC or any other financial news channel, you’ll see “experts” all day long telling us what the markets have done, what they are currently doing, and more importantly, what they will do in the future. So why all the uncertainty? It‘s because the financial markets are not exactly scientific and therefore not quite as predictable. In fact, far from it.
Financial markets are based on emotion, are random, and have no specific pattern associated with them in any way shape or fashion. As a species, we don’t do well with randomness. So much so, in fact, that we have a natural tendency to find patterns and sequences in everything we encounter so that we can predict an its outcome. Even if we are told that something is completely random, we will still try to figure out a pattern and try to predict the end result. We do this because It is simply our way of trying to explain something that we don’t understand. According to psychology professor George Wolford of Dartmouth College, it is part of our biological and physiological make up. We can’t help it. In fact, without it, we probably would not have survived as a species. It is actually what sets us apart and helps us thrive over other animals. However, when it comes to the randomness of the markets, it is a trait that hurts us more often than it helps us.
Thirty-seven hundred years ago, in ancient Mesopotamia, the first clay model of a sheep’s liver was baked, and it was to be used as a training tool for specialized Babylonian priests, known as Barus. These priests believed that by studying the guts of freshly slaughtered sheep, they were able to make predictions about the future. This clay model was designed as a catalog of the varying colors, blemishes, and size or shape that the liver of a real sheep might display. The Baru and his followers believed that each of these variables could help predict what was about to happen. The clay model (training device) was subdivided into sixty-three distinct areas, each marked in cuneiform writing and other symbols, describing its predictive powers. As described by Jason Zweig, what makes this artifact so outstanding is that it is as contemporary as the coverage of today’s financial news. “More than thirty-seven hundred years later, the liver reading Babylonian Barus are still with us, except today they are called market strategists, financial analysts, and investment experts.” Instead of a sheep’s liver, these modern Barus use powerful computer software and other technologies to justify their forecasts, much like a weatherman. However, unlike a financial “expert”, a weatherman has actual science to back up a forecast, making him right more often than he is wrong.
In the unscientific financial world, predictions have two fundamental flaws: First, they assume that whatever has been happening is the only thing that could have happened, and second, it relies on the short-term past to forecast the long-term future. A recipe for disaster, given that financial markets behave randomly. If you have two coin tossers and they toss a coin five times each and one has an outcome of tails five times in a row and the other has an outcome of tails only three out of the five times, chances are that most people would bet that the first tosser’s next outcome would be tails. After all, tails five times in a row seems quite impressive. The reality is that, statistically, the chance for an outcome of heads remains the same as it does for tails.
If we were to always keep this in the back of our minds, we might have second thoughts about being impressed with a financial “expert” simply because he or she was right about the latest couple of moves in the market. For the same individual being right about the next move in the market has an equal chance of being wrong. If you look at the history of most “experts”, they have been wrong more often than they have been right. Interestingly enough, the Wall Street Journal once stated, “If pilots’ vision were as bad as economists’, Amtrak would be profitable.”
Knowledge is key to making any decision and in the financial world this is no exception. Most of us know that the markets are unpredictable. The knowledge that we tend to latch on to market predictions, which are essentially baseless, is a part of our biology and therefore seems to make sense. Understanding how our investing brain works along with its constant need for trying to bring order to randomness, it might bring to light the importance of having a well prepared, functional, and flexible retirement plan that allows for change