More than 60 years ago, social psychologist Leon Festinger and two of his associates infiltrated a cult. The cult leader, whom the researchers called Marian Keech, convinced her members that the world was going to end on December 21, 1954. She said a flying saucer would land in her back yard at midnight, December 20th. It would scoop up the faithful and take them to safety.
Expecting to emigrate to another planet, plenty of her followers quit their jobs, gave away their savings and their homes. On the night of December 20th, they huddled together, waiting for the saucer in Keech’s back yard. Her husband, who thought the whole thing was crazy, lay asleep in bed.
Midnight came and went. At 2am, they grew worried. At 4:45 am, Marian Keech had another vision: God spared the planet thanks to her group’s faith. This was proof they were right. They called the press to report the news, and then they hit the streets. They tried to convince people that Marian Keech saved the world. Festinger, the social psychologist who watched this in wonder, coined this bizarre behavior “cognitive dissonance.”
It’s a common term today. It describes clinging to a set of beliefs, even when we’re faced with facts that say we shouldn’t. This happens to everyone. We demonstrate it daily in our harmless biases. It shows up in our political views and our prejudice, too. Anyone who says, “Well, that never happens to me,” is as deluded as those in Marian Keech’s group. That’s according to social psychologists Carol Tavris and Elliot Aronson, authors of Mistakes Were Made (but not by me).
We view the world through lenses that support our own ideas. We almost never say, “I was wrong” when facts conflict with our beliefs. But if we could say that, the world would be better, and it would be easier for investors.
Human beings dislike uncertainty. It’s unsettling. And according to economic Nobel Prize winning psychologist Daniel Kahneman, we dislike losses twice as much as we like gains. That’s why forecasts about financial doom and gloom grab millions of eyeballs and hearts. We might not believe we can see the future. But the notion that somebody else can brings comfort and support.
I recently received an email from some friends of mine. They are convinced that U.S. stocks and the U.S. dollar are going to crash. They want to shovel their money into foreign currencies and then dive back into U.S. assets before they recover.
That requires two levels of successful speculation: getting out at the right time, and getting back in. It’s highly unlikely that they can do one, never mind both.
They have read my investment books. They have also read my columns. I consistently assert that market timing doesn’t work. If somebody guesses right once, they usually stroll back into the casino and give it all back.
But stock market forecasts tempt almost everyone. They even tempt people who should know better. For example, when leading financial experts and economists are asked, “Will stocks rise or fall this year?” plenty say, “yes” and plenty say, “no.” But over time, these experts are more often wrong than right.
If you’re asked the same question (whether stocks will rise or fall this year), say “yes” every time. After all, historically, U.S. and global stocks have recorded calendar year gains two out of every three years. By saying, “yes,” every year, you would beat the pros.
We have proof of that. When financial experts and leading economists asserted whether stocks would rise or fall, CXO Advisory tracked their success rate. They assessed 6,627 forecasts by 68 leading financial experts over an eight calendar-year period from 2005-2012. If you guessed stocks would make money every year over the same eight years, you would have been right 87.5 percent of the time (only 2008 saw stocks decline). But none of the experts came close.
On average, they were right just 48 percent of the time.
Even those with famous track records usually fail in this pursuit. Such was the case with Protégé Partners. They bet Warren Buffett they could pick a group of hedge funds that would beat the S&P 500. They picked brilliant managers with winning records. But Buffett won that bet. He’s one of the few investment gurus who admit he never knows where stocks are headed, year-to-year.
When an expert appears to know how to move money around, it attracts a lot of attention. Such is the case with hedge fund manager, Ray Dalio. He attracted reams of investors who believed he had a working crystal ball. But at the height of his popularity, his magic ceased to work. Over the past eight years, his remaining investors experienced cognitive dissonance.
Plenty of professional traders claim they have an edge. Many of them run tactical asset allocation funds. If these managers think the U.S. dollar is going to crash, gold is going to rise or emerging market stocks will soar, they position their funds to take advantage of these swings. But when I calculated their returns, these market forecasters proved to be nothing but smoke and mirrors.
The financial media doesn’t help. Every week of every year, they report headlines such as these:
The Expert Who Predicted The ‘87 Market Crash Says We’re Headed For Another 1929
Bond Expert Explains Why He’s Selling Bonds Now
This Man Bought Netflix At One Dollar A Share. Here’s What He Says You Should Buy Today
Experts Who Predicted The 2008 Financial Crisis Say Dark Times Are Ahead
Smart investing isn’t about trying to see the future. That’s almost a surefire way to underperform. Instead, investors should accept that the future is uncertain. It always has been, and it always will be. To provide the best odds of investment success, investors should maintain a diversified portfolio of low-cost index funds. They should include U.S. stocks, international stocks and bonds.
Such a portfolio, when it isn’t messed with, beats most of its professionally managed counterparts, decade after decade. The Nobel Prize winning economist, William F. Sharpe, explains why in his paper, The Arithmetic of Active Management. The SPIVA Scorecard and the SPIVA Persistence Scorecard prove he was right.
That’s why investors shouldn’t speculate. They shouldn’t alter their allocations based on expert opinions or emotions. Nor should they keep cash on the side, waiting “to invest at a better time.”
However, staying the course with a diversified portfolio is easier said than done. We have trouble accepting facts that conflict with our beliefs. The biggest risk to your portfolio isn’t the market itself. It isn’t the economy or the U.S. dollar. Cognitive dissonance is a far bigger threat. One way or the other, it affects every human being. That’s why it’s the single biggest threat investors face.
Perhaps, when you’re tempted to speculate, remember Marian Keech’s husband. When his wife and friends stayed up late to welcome aliens, he just went to bed. He got a good night’s sleep. He likely knew nobody could see the future…least of all, his charismatic wife.
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas