With the 2018 midterm elections tomorrow, I noted a similar conceptual approach between a political forecast website I follow called FiveThirtyEight (www.fivethirtyeight.com) and the evidence-based approach to investing. If you are not familiar with FiveThirtyEight, it is a political and sports forecast website developed by statistician Nate Silver.
What I think is instructive is his view of uncertainty of future events. Political media narratives suggest that political outcomes are deterministic (i.e. who will win an election) where, in fact, the future is much more uncertain than that. A clear example of this was the 2016 presidential election in which the accepted narrative was that Hillary Clinton would win the election. When, instead, Donald Trump won, there were stories about how the election polls got it so wrong.
However, a more nuanced view of polls leading up to the election showed that Donald Trump had a non-trivial chance of winning. In fact, the FiveThirtyEight model gave Trump a roughly one in three chance of winning on election day. We know that one in three type events happen all the time and yet many (most?) were shocked at the outcome.
I believe that investors have a similar (deterministic) view of markets (i.e. will the market go up or down). There is no simple way to answer that question. And in fact, trying to do so leads to the type of betting mentality that many advisors and their clients mistake for investing. We cannot successfully predict future returns with precision. All we can really say (without simply making things up) are that market returns could fall in a range over long periods of time. Yes, this is a very unsatisfying answer to the question of ‘what will the market do’ but it is the only honest one. By taking a probabilistic (FiveThirtyEight Model- type) view of markets, investors can achieve a better investment experience and be better prepared for an uncertain future.
is the founder and principal of Westchester, New York-based, Fifth Set Investment Advisors LLC, a Fee-Only, SEC registered investment advisory firm. Following a career in equity research, an examination of competing investment management approaches led Ian to create Fifth Set to offer clients customized wealth management strategies built on a foundation of evidence-based financial theory.