Those who have knowledge don’t predict. Those who predict don’t have knowledge. – Lao Tzu, Chinese Philosopher, 6th century BC
I recently came across this quote in a hedge fund’s performance update letter to clients. As many of you know, humans are not well-suited to predict the future. When something dramatic happens in the markets, people tend to react after the fact. They tend to be “caught off guard”, then over-react or under-react after events unfold.
What does this mean to you as an investor? The fact that nobody can effectively predict markets can teach you a few things. First, it can help you to detect if an investment manager, advisory firm, or other investment “professional” is misleading you. By knowing that nobody can predict markets effectively, seeing or hearing these terms should evoke immediate skepticism:
- Guaranteed Returns
- No Risk
- Limited Downside
- Day Trading
- Market Timing
- Technical Analysis
For more information on doing due diligence on a financial advisor, please (See Article: Financial Advisor Due Diligence).
Secondly, knowing that people can’t predict markets can help you manage your expectations when selecting an investment manager. Since people can’t predict markets, don’t expect them to. Avoid any gimmicks that claim to consistently beat the market. Don’t place too much emphasis on Morningstar Ratings or historical performance of an investment or manager.
Good historical returns have absolutely NO IMPACT on future performance. Although this fact is commonly ignored by most investors, there is a reason why you always hear the commonly used disclosure, “The performance data given represents past performance and should not be considered indicative of future results.”
If you are seeking investment advice or to hire someone to manage your assets, don’t look for someone who can “beat the market.” Don’t look for someone who has great past performance or who can predict the future. Find someone who can give you exposure to your target asset class as efficiently as possible. Understand how your advisor is paid and what that means to your portfolio. For more information, please (See Article: How Do Financial Planners Get Paid?) We will also be doing a follow-up article that explores the impact of fees on your portfolio.
Interestingly, in the same day I came across the Lao Tzu quote, I read a report of hedge fund performance figures through May 2013. It was pretty grim. It reinforced the idea that nobody, even the “masters of the finance universe”, can predict the direction of markets for any meaningful amount of time.