Weather Forecasts
You might live in a place where the weather is pretty predictable. In Texas, we don’t have that luxury. The only thing that is predictable is that it will be HOT in the summer. But in the spring, fall, and winter, will it be 80 degrees? 40 degrees? Will it freeze in May? Maybe. Will we burn up outside in February? Possible. Maybe it will rain for several weeks after a months long drought. We just never know what to expect.
Weather forecasters have to hang on for the ride, and thanks to great technology and study, they are able to tell us what to expect for a few days ahead. We can be prepared for a sudden cold front or violent storm headed our way.
What meteorologists aren’t great at is predicting long-term weather forecasts. How many times have they given a claim in the spring that the summer will be rainy and then there’s a drought? Or said this may be our coldest winter on record and then the winter is pretty mild? Meteorologists admittedly can’t predict long-term weather very accurately.
If you’ve ever watched the early forecasts of a hurricane that weathermen are watching develop in the ocean, they will identify a “cone of uncertainty.”
This cone represents the path they predict the storm will take, but with margin on either side to cover their inaccuracies in what it may actually do. The cone is very narrow over the next 24 hours because they are able to predict that path with some certainty. However as they predict several days in the future the cone gets wider and wider (more uncertainty) as there are more variables to consider.
Investment strategy works in the opposite way. When we look at what kind of returns the stock market will give us this week, month, or year we do not have much certainty at all. It’s a very wide cone short-term because there is more uncertainty.
But when we look at the history of the stock market, we see that the longer you keep your investment in the market, the more likely you are to have an average, positive return. If you try to model what your annualized portfolio return might be over 20 or 30 years it is more predictable. Your cone of uncertainty narrows in as your time horizon expands.
I hear a lot of people say they are scared of investing in the stock market because they have no idea what it will do day-to-day. They are exactly right! Even the stock analysts have a hard time predicting the short-term trends in the market.
Take some comfort in knowing that we are able to look at the last 100 years in the stock market and see what the long term trends are and how it reacts to different events throughout history.
If you find the market to be a scary place and you want someone to show you the research behind its long-term trends, reach out to me! I love to teach, and I love to show people how to create an investment plan for the long term.
