Managing investments – the one true certainty about the future and the black swan

The more uncertainty there is in global financial markets, and the more volatility in asset prices, it seems the more voices can be heard predicting the future. You can see it on the traditional media of television, hear it on the radio and read it in newspapers, and you can also see it on every social media platform, with predictions and opinions being shouted to the world.

At Extended Investments Limited, we have a very clear position on predicting the future: you cannot do it with any accuracy. We do not know, with absolute certainty what will happen next week, next month or next year. This goes to the core of our philosophy and indeed our name.

If you can’t know the future, what can you do?

When we state our position that we do not know with certainty what will happen in the future, the obvious next question we get is can you still plan for the future?

Our answer is yes, you can and you should plan for the future.

In fact, the question of can you predict the future, is, we believe, not the right question. It is not a matter of what the US Treasury 10-year bond rate will be priced at next week, or the price of a particular stock or market index next month.

The first and most important question for an investor to answer is “what are their goals?”. To know where they want to be in ten years, for example, is what should drive investment decisions, rather than how an asset price has moved or is expected to move.

Our philosophy is an application of the principle of the Black Swan theory, espoused by Nassim Nicholas Taleb. He defines a black swan event as something that can be positive or negative, that is not predicted, expected or foreseen, but which, when it occurs has a substantial impact. The other principle is that many people after the event will have claimed they could see it coming (but not before), which he calls retrospective predictability.

A positive black swan could be the technology revolution of the late 20th century. A negative one may be the collapse of the mortgage lending structured investments causing the financial crisis of 2008.

When we apply this theory to managing clients’ wealth and helping them to achieve their goals, we posit that we will probably not know what the next black swan event is or when it will happen but do know there is likely to be one. Therefore, we apply contingencies for clients to plan for potential extraordinary events. We aim to build such contingencies into every client plan to reduce portfolio, investment and financial plan fragility.

This leads us to the dangers of predictions.
The first danger of predictions is that most are wrong. The second danger is that the risk of an incorrect prediction is not balanced but can be felt more heavily by the investor rather than the person making the prediction.

There is a saying that economists have predicted ten of the last four market downturns! This captures that risk imbalance. If an economist makes the prediction ten times and is right four times, it is the four times that are remembered. The other six are forgotten and the economist hasn’t risked much, except maybe their reputation, as they go on to espouse how they predicted those four recessions.

For the investor that took their advice though, if they reacted each time to the economist’s advice, they may have lost six times out of ten. The predictor is saying, and the investor is doing. That is the danger of predictions.

The real message here is to be careful where you get your advice and predictions (market forecasts) and even more so, be mindful of how you apply them to your situation.

Our approach is to build investment strategies for clients based on their goals and objectives, then adapt them to the market conditions and economic cycles, and not the other way around. Don’t get caught up on what might be the next big thing or the next potential crash. For a more aligned approach, review your portfolios by ensuring they are in line with your goals and checking they are on track to hit your targets. Focusing on the end goal can remove unnecessary risk-taking, stress and potential losses.

We know that volatile markets make for a stressful time and one of the hardest things can be to stay the course. We are here and available if you would like to speak with us about your investments, your financial plan or how to create a plan, to get advice or for a second opinion. Contact us at info@extinvestments.com and we will be happy to speak with you.