Abandoning the Addiction to Prediction

Investing with clarity is based on understanding the knowable areas of the market, incorporating fundamental market principles and applying strategies that do not depend on predictions. By doing so, advisors provide more solid, informed advice to their clients, grounded in a clear understanding of the market rather than speculative forecasts.

Key market precepts promulgated by market iconoclasts including Roger G. Ibbotson and commentator Jeremy J. Siegel suggest that investing in equities over the long term has been the greatest path to wealth creation. Over the course of the last 97 years, stocks have historically provided superior performance versus fixed income securities (such as municipal bonds, government bonds, and Treasury bills) when taking into account both taxes and inflation. Other precepts include:

• Negative returns are relatively rare compared to overall positive returns

o Since 1926, the market has had four rolling 10-year periods where returns were negative.

o From 1926 onward, the stock market has not produced a rolling 16-year or longer period where returns were negative.

• Dividends are an important key to returns

o Dividends are a key factor in total return from equities, averaged over rolling 5-year periods. If you invested $1 in the S&P 500 at the beginning of 1950, assuming you reinvested all dividends, you would have achieved a return on investment of 262,677.57%, or 11.28% per year.

• Equity returns include intrinsic risk

o Equity returns might be lower in the future – which is always a possibility.

o This would not necessarily be because of reduced intrinsic worth, but rather the result of higher barriers to entry. With higher costs and more unstable markets come a demand for higher returns on a gross basis. Increased access and lower costs could circumvent this demand.

By acknowledging the aforementioned principles and focusing on long-term trends rather than short-term predictions, advisors are poised to provide more reliable advice. This approach, which emphasizes historical market trends and the inherent value of equities, can guide clients towards making more informed decisions, potentially leading to better investment outcomes as well as enhanced client satisfaction and loyalty.

Clarity is also achieved by better understanding the issuing companies that comprise a client’s portfolio. This is achieved by deploying various strategies that do not rely on predictions. For example, dividend capture involves focusing on capturing income from dividend-paying stocks. Intrinsic value analysis entails examining company fundamentals such as the business model and competitive advantages. Additionally, a disciplined pricing strategy recognizes that stock prices rarely follow a straight line, setting prices for buying and selling to reduce emotional involvement.

All too often, I have seen investors become distracted from reality, driven by anxiety and fear created by uncertainty. To alleviate this condition, investors are drawn to self-proclaimed experts who confidently claim that they can forecast market fluctuations. This overconfidence, which is perhaps more aptly described as arrogance, may lead to subpar outcomes. This phenomenon is known as the Dunning-Kruger effect, a cognitive bias where individuals mistakenly assess their expertise or skill level higher than it truly is in a certain domain.

Additionally, investors can be particularly susceptible to stories about specific securities and issuing companies and often rely more on persuasive narratives than unvarnished facts. When meaningless predictions are combined with the power of storytelling, the dangerous and misleading narratives that result may push investors into an irrational state where they continue to make poor choices. Instead, investors and advisors alike should embrace uncertainty where it legitimately exists and focus on known market precepts and workable strategies that do not depend on predictions.

Conclusion

As a financial advisor, fostering clarity in your investment strategies and client communications is paramount. This involves actively listening to and comprehending your clients' long-term objectives, whether it's achieving homeownership or funding their children's education. It's about maintaining a well-defined market focus that you can articulate effectively.

Specializing in specific industries, continuously assessing factors like industry growth, business cycles, and regulatory shifts can lead to more reliable investment recommendations. Advisors should be adept at explaining the fundamentals of individual businesses and their growth potential, placing them in the broader context of the industry landscape.

These clear, fact-based dialogues, devoid of speculative predictions, serve to significantly reduce uncertainty and confusion for your clients. In a world filled with overconfidence, persuasive narratives, and the allure of empty predictions, advisors who champion clarity play a pivotal role in guiding their clients through uncertainty toward a more promising financial future. By prioritizing known market principles and actionable strategies, advisors can not only enhance their practice but also provide invaluable services that transcend the illusion of prediction.

Mark Pearson is the founder and chief executive officer at Nepsis®, a national financial advisor and investment management firm. Advisory services offered through Nepsis, Inc.; An SEC Registered Investment Advisor.

A message from Advisor Perspectives and VettaFi: To learn more about this and other topics, check out our podcasts.

Read more articles by Mark Pearson