The Danger of Stock Market Forecasts

Carl Richards is a certified financial planner in Park City, Utah. His sketches are archived here on the Bucks blog, and other drawings are available on his personal Web site, BehaviorGap.com.

January marks the time of year where gurus come out of the woodwork with their stock market forecasts.

I thought it would be valuable to review a few of them and try to understand what they might mean to real people investing in the real world. I’ll cover two recent forecasts and  one from a few months ago, too. Let’s begin with Robert Prechter. In July, 2010, he said that based on his version of something called the Elliott Wave principle, “the Dow, which now stands at 9,686.48, is likely to fall well below 1,000 over perhaps five or six years as a grand market cycle comes to an end.” Since then, the Dow has been up sharply.

Then we have Robert Shiller of Yale. He recently put his price target for the Standard &Poor’s 500-stock index at 1,430. (At this writing, the index is currently about 1,280.) Before you get too excited, note that Mr. Shiller says that his prediction is for 2020. That works out to less than a 1.5 percent increase a year for the next decade! Finally, there’s Laszlo Birinyi. According to a recent Bloomberg Businessweek article, Mr. Birinyi believes the S.&P. can hit 2,854. And in an amazing display of precision, he predicts this will happen on Sept. 4, 2013.

So there we have it. Three market gurus with three wildly divergent forecasts that were all covered and reported by reputable, mainstream news outlets.

What’s a real investor to think or do?

The problem with gurus and their guesses is not that they’re always wrong. Part of what makes these forecasts so tempting is that the gurus are right just often enough for us to believe that there’s merit in listening. Unfortunately, it’s incredibly difficult to identify which forecast will be right.

So what does a real person do with this information? I suggest you use it as kindling, as a starting point. I know it’s fun to chat with friends or colleagues about your opinion of the stock market. I also know it can feel like the duty of any self-respecting American to have an opinion about the market and the economy. Having an opinion is fine. But acting on it with real money is often incredibly damaging. To move beyond opinion you can start by doing the following:

    * Realize that investing is a means to an end and not the end in and of itself. Take the time to define the end (your goals), and realize that good investment decisions are only made within the context of your life.
    * Once you define your goals, figure out what it will take to get you there. Part of that will obviously include a rate of return that you need to achieve. If that rate of return is unrealistic, then make adjustments to your goals. For example, you can try to save more, you can spend less or you can delay goals like retirement.
    * Once you have a realistic set of goals, build the most conservative investment strategy you can to get you there.

You need to realize that no one can tell you with any sense of precision where the stock market (or any market) is going. If you’ve learned nothing else during the last 10 years, I hope you remember that the stock market won’t perform in a set way indefinitely. At some point the market will go down, and it may be for a long period of time. Just as likely, the market will often go up a lot over a long period. So for the real investors who are investing real money in the real world, take note that you should build your investment strategy around your life and your goals and not the annual guesses of gurus.