‘It’s Kind of Amusing How Terrible Forecasts Are’

On this episode of The Long View, Barry Ritholtz, author, podcaster, and co-founder, chairman, and chief investment officer of Ritholtz Wealth Management, breaks down how saying “I don’t know” can be a superpower when it comes to investing.

Here are a few excerpts from Ritholtz’s conversation with Morningstar’s Christine Benz and Amy Arnott.

Why People Gravitate Toward Market Forecasts

Amy Arnott: You’ve written extensively about the fact that nobody knows anything, and you go through a bunch of examples in the book about how this applies to different areas like movies, music, television, economics, policy, market trends, etc. But why do you think people still latch onto predictions and kind of gravitate toward experts who make forecasts?

Barry Ritholtz: So, there’s a couple of reasons. People are very unhappy with the general concept that the universe is somewhat random. And frequently our expectations are derailed by wholly unanticipated events. Right? So, my favorite few examples: Nobody had in their 2020 forecast “a global pandemic is going to shut the economy.” Nobody had in their 2022 forecast “Russia is going to invade Ukraine” and “oil is going to shockingly come down in price.” I’m sorry, that was ‘21, ‘22, I don’t remember which year, or heading into 2022, “the fastest rate-hiking cycle that’s going to lead to negative double-digit returns for stocks and bonds.”

Like, all these events happen, and even some events that are sort of anticipated, like the Fed hiking cycle or the Russian invasion of Ukraine, they just derail our hopes and dreams somewhat randomly. So, there’s a tendency to want some form of certainty. We are social animals. We are primates that evolved in a group. So, we want a strong leader who’s confident and can tell us what’s going to happen and keep us safe. And in fact, the academic studies show us a couple of shocking things about forecasters.

First, generally speaking, the more specific a forecaster is, the more the viewers or readers like them. So, two people go on financial TV, what do you see for the next year? One says, “Well, the future is inherently unknown and unknowable. The average returns for the market is between 8% and 10%. Let’s just tack on another 8.5% from where we are.” And the second person says, “We like the tailwind of consumer spending and likely upcoming tax cuts. And I see the Dow at 48,753.” Kind of like the old joke: Why do economists use two decimal points? To demonstrate they have a sense of humor.

So, the viewer loves that specific forecast. In fact, anyone who makes an outlier forecast that comes true, the tendency is for them to continue to make these bigger outlier forecasts, to be wrong more frequently than the average forecaster, and to really be believed by readers and viewers. And when you look at Philip Tetlock, University of Pennsylvania, professor at Wharton, talking about expert judgment and forecasts, the average expert is no better than the average layperson in making forecasts and the average layperson is no better than a roll of the dice. So, we’re really bad at this as a species, probably because a year is a long time. And 12 months is plenty of time for something randomly to just enter the picture like a pandemic or a war or something else and just disrupt our forecast.

Why Do Market Forecasts Feel More Wrong Than Usual?

Christine Benz: It seems like the forecasts have been especially bad over the past few years. Well, I guess some people saw inflation coming in 2021 and 2022. And then, last year, 2024, everyone thought we’d have lots of Fed rate cuts that didn’t materialize. So, does it seem like forecasts have been even more wrong than usual? And if so, why is that happening?

Ritholtz: I think, to a greater degree, people are paying closer attention to it. They’ve just been wrong for my entire career. It’s kind of amusing how terrible forecasts are. And we see, by the way, we see a little less of this than we used to. There used to be the Businessweek annual forecast and Wall Street Journal did it and Fortune did it. Those sort of contests have kind of tailed off because it was always pretty random who won. And if you, depending on the date it ended, you go a day forward or a day later and the final numbers are just completely different. It really is very random. I think that, between media generally and social media, I think there’s a greater awareness of the problem with forecasts. I think people see it more. So, it’s a little bit of an availability issue. We are just kind of recognizing that this is a terrible way to make investments.

Now, you go back to the ‘60s, ‘70s, ‘80s, forecasts were great marketing. Someone would put out a piece. Here’s what’s going to happen next year. They would go on TV. They would show up in the Barron’s or the Journal, and it would generate a lot of business activity, especially if you’re transactional. Forecasts are great if you want to drop a ticket and charge a commission. But for someone who’s buying and holding a portfolio for the next, fill in the blank, 20, 30, 40 years until they retire. Forecasts 12 months out, they’re less than useless—they’re destructive because we have a tendency to marry forecasts to our portfolios and make bad decisions based on those forecasts.

So, I think this is less than, it’s not that forecasts are more bad today than they’ve been over the past 100 years. We seem to be more aware of it. And once you start—I wrote a piece for the Street.com in like ‘05, “The Folly of Forecasts.” Once you start to see how bad these are … it’s the old joke about science advancing one funeral at a time. It’s taken a while for us to evolve past all these forecasts. I used to be one of the few voices whining about this.

Now, every year you’ll see a piece in The Wall Street Journal, you’ll see a piece in one of the magazines, you’ll see that someone will describe, “Hey, it’s silly season, brace yourself for all these dump forecasts.” That wasn’t true 20 years ago. I think at least some people have kind of realized how bad this is. And the reason I mention things like The Beatles and John Wick and Squid Game and things like that, it’s shocking when you see how terrible even the experts are at forecasting and trying to anticipate what the public’s opinions are going to be in a few years, what their tastes are going to be, what they want to see or listen to. I use those examples in the book to kind of remind people nobody really knows what’s going to happen in the future. Don’t build a portfolio based on—you know, you don’t have to be Nostradamus. And in fact, even Nostradamus wasn’t Nostradamus. Making investments based on your predictions are likely to lead to suboptimal results.

The Power of Saying ‘I Don’t Know’

Arnott: Related to that, you write that investors have to be willing to say “I don’t know,” and that being able to say that is kind of a superpower. How can people get more comfortable, not just with not knowing, but admitting that they don’t know?

Ritholtz: Yeah. This is kind of a pushback to the “fake it until you make it” idea. The cockiest people, especially when we follow the Dunning-Kruger curve, are people who really have no awareness of their own lack of skills and knowledge. You have to have some degree of intellectual self-confidence to say “I don’t know.” I have a vivid recollection during the Enron era of Jeff Skilling really abusing analysts who would ask questions about “This business model doesn’t make any sense to me. Can you explain it to me?” And he would harangue them and say, “You’re obviously too stupid to cover us.” What he’s really saying is anyone who admits they don’t know, I’m going to single out. To say that to someone like Skilling, or more recently to Theranos or some other frauds in history, you have to say “This doesn’t make any sense to me.” You know what was fascinating about Theranos was they had this really amazing list of board members and just crazy, well-regarded people, and yet none of them were biotech or medical-device venture capitalists. So, the entire VC community that specialized in healthcare and devices and medicine passed on it, and everybody else who showed up, they all seem to rely on each other’s reputation, but nobody did the work. If someone would have said, “Wait, I don’t understand this. I went to medical school and when you just, instead of tapping a vein, when you just do a pinprick, you’re getting all sorts of other contaminants along with the blood. How do you deal with that?” John Kerry, whose book is amazing, going through all this.

But you have to say “I don’t know” if you don’t know. And if someone says “You’re an idiot, you’re not smart enough to invest in this company.” The correct answer is, “Well, I’m not an idiot, but clearly, you are not comfortable explaining it.” And my spidey sense says: If you can’t explain this to a 10-year-old, then it’s probably not worthy of my money. That is really important.

You have to understand what you’re investing in. And if you don’t, move on. It really was an important lesson that Jeff Skilling accidentally taught us. Anybody who responds to the question “I don’t know” with derision and ridicule, I don’t want to say they’re a fraud, but they’re certainly not worthy of your money. Jeff Skilling was a fraud, and Ken Lay was a fraud. But it’s an important lesson. If you don’t understand it, then don’t put your money into it.