Another year under the belt, and what a great year it was for stock market returns. At the close of each year, I like to look back and see what the “experts” predicted we would see. I reviewed some of the headlines from January 2017. On CNBC’s website on January 3, 2017, the headline states in part, “Wall Street’s forecast is the most bearish annual outlook in 12 years.” In this article, CNBC compiled predictions from 16 Wall Street firms concerning where the S&P 500 would end up for the year 2017. The predicted range was from 2,300 to 2,500, with an average of 2,362. The S&P 500 closed out 2017 at 2,673.61, 173 points higher than the highest prediction of all 16 Wall Street firms and 311 points higher than the average prediction.
What does this tell you about how we should look at financial predictions from the experts, or for that matter, anyone’s predictions? Personally, it tells me to look at these predictions as entertainment. No one is able to predict the future of the stock market with any more accuracy than predicting the next roll of the dice at the craps table, and once we realize that, we can focus on the things we can control instead of wasting resources trying to figure out who can accurately predict the market. I wonder why, year after year, people make investment decisions based on the predictions of others when the research shows that the accuracy rate of these predictions is quite dismal. By the same token, when I’m in Las Vegas, I like to watch people at the craps table. There will always be those who think they can predict the outcome of the next roll of the dice. When they’re right, they become the “expert” at that table. When they’re wrong, they blame it on the table. As I watch this behavior at the craps table, it answers my own question about why some people continue to make investment decisions based on the predictions of their favorite expert.
So if predictions are merely entertainment, what should we focus on in making investment decisions? Here are some of my recommendations: 1) Diversify your portfolio. 2) Invest for the long term. 3) Remember to consider income taxes.
- Diversify your portfolio. Unless your portfolio is several million dollars, the only way you can truly diversify your portfolio is to use mutual funds. When choosing mutual funds, it’s important to choose funds that have low expense ratios and that will properly maintain their mutual fund asset diversity. Some mutual fund managers believe they can predict market movements and invest their mutual fund dollars in assets they believe will outperform the market. As their predictions change, they move their assets. This can increase the expenses of the fund, which will most likely reduce your return on your investment.
- Invest for the long term. The market has in the past, and will in the future, have periods of ups and downs. Over the last 90 years, the S&P 500 index has seen average gains of around 10%. However, when you look at each individual year, the S&P 500 return has ranged anywhere from a high of approximately 54% to a low of approximately negative 43%. In fact, there have only been six years in the last 90 years that the S&P 500 has earned within 2% points of its 10% average, that is, a return between 8% and 12%. The other 84 years showed returns lower than 8% or higher than 12%. If we are in the market for the short term, we might be in one of those negative years. If we then take our money out of the market, we will not get the long-term average return. We will be stuck with the short term loss.
- Income taxes. Successful investing takes all income and expenses into account, including income taxes. Having gains taxed at the lower capital gain rate will increase your actual after-tax return. Utilizing all types of accounts and knowing which assets are most efficiently held in which accounts can increase your after-tax return. In general, the accounts I am referring to are ROTH IRA accounts, traditional IRA/ 401(k) accounts, and taxable accounts, to name a few. In addition to understanding which assets should be held in which kinds of accounts, it’s important to know which accounts we should use to pay expenses or draw funds from when funds are needed.
Knowing that the predictions you read or hear are primarily for entertainment and not foolproof investment advice will help you become a better investor as you focus on the aspects of investing over which you actually have control.
John D. Parry is a financial advisor with Onyx Financial Advisors, LLC, an independent fee-only registered investment advisor firm located in Idaho Falls, Idaho. He can be reached at (208) 522-6400 or at www.OnyxFinancial.com.