by James Parkyn
To kick off the new year, our Capital Topics podcast looked at investing lessons from 2022. In this article, I want to focus on two of those lessons because they are so important for your financial health.
For our first lesson, we looked at last year’s events to see what they could teach us about what’s to come in 2023.
That’s just what’s done by the many financial experts who produce forecasts about the economy and the markets. We take a different approach. We look at those forecasts and wonder why anyone would pay attention to them.
To understand our attitude, let’s step back a year and consider some of the events you would have had to predict at the beginning of 2022 to have made winning bets.
Russia’s invaded Ukraine to start the biggest land war in Europe since 1945.
For the first time ever, both U.S. stocks and long-term bonds registered double-digit losses for the year. Value stocks outperformed growth by the largest margin since 2000, amid a tech stock crash.
Runaway inflation took hold around the world, including rising to a 40-year high in the U.S. Major central banks hiked interest rates aggressively in response.
China abandoned its zero-COVID policy as its economy stalled and widespread street protests emerged.
No one could have predicted these developments, but that’s not unusual. Every year, the markets are buffeted by unforeseen events that make a mockery of expert forecasts. If you want another example, look no further than early 2020 and the start of the global pandemic.
Yet, economists, analysts and money managers continue to confidently predict what’s going to happen at the beginning of each year. Why? It’s precisely because the future is unknowable that people crave the illusion of certainty that comes from predictions.
“The inability to forecast the past has no impact on our desire to forecast the future,” financial author Morgan Housel writes. “Certainty is so valuable that we’ll never give up the quest for it…”
Despite this deep need for certainty, one of our most important lessons from 2022 is to ignore the forecasts and outlooks. Instead, we recommend you focus on maintaining a steadfast commitment to controlling risk through broad diversification and a long-term investor mindset for whatever may come in 2023.
The second lesson we take from 2022 is related to the first. It’s to watch out for hindsight bias in your thinking and decision-making. This is the tendency to look back and delude yourself into believing you knew what was going to happen all along.
Writing in the Wall Street Journal, Jason Zweig explained it this way: “Countless hunches and gut feelings flicker through our consciousness over the course of a year. We naturally remember the ones that turn out to be right. The multitude of other hunches that turn out to be wrong go into our mental garbage can.”
Zweig writes that that hindsight bias translates into “what if” thinking. What if I’d only acted on this or that hunch last year, I would be so much richer today. However, our memory of past predictions is often faulty.
To prove the point, Zweig surveyed readers of his newsletter in late 2021 and asked them to forecast where a series of market indicators would be in a year’s time. Then, a year later he asked them to recall those predictions with the knowledge of how the year had actually turned out.
On average, the readers’ recollection of their forecasts was closer to how the markets actually performed in 2022 than their predictions back in 2021, which turned out to be far too optimistic.
This points to the human tendency to reconstruct the past based on what we know now. As Zweig notes the danger is that mistakenly thinking you knew what was going to happen in the past may lead you to think you know what’s going to happen in the future.
For more insights on how to navigate the markets, please check our PWL team website. And if you’re not already a listener of our monthly Capital Topics podcast, I encourage you to download the latest episode and subscribe to receive future episodes.