It’s an annual rite in finance. As year-end approaches, investment strategists up and down Wall Street burn the midnight oil churning out projections for the new year. Predictions for the S&P 500 lead the publication frenzy, followed by prognostications on market conditions, interest rates, valuations, and the overall economy. From bulge bracket banks issuing equity outlooks to analysts predicting commodity futures, there’s no escaping the deluge of forecasts.
But how accurate are these forecasts? Should we pay heed or view them as no more than educated guesses dressed up as insight? Unfortunately, historical performance has shown that forecasting has added little value for investors.
The Flaws in Forecasting
The glaring weakness in financial forecasting is its less-than-stellar track record. For example, over the past 16 years, strategists have underestimated the S&P 500’s annual performance in 13 of those years and missed price targets by approximately 10% on average.1 Last year, an average of 2024 strategist forecasts predicted a year-end close of 4838 for the S&P 500,2 while the actual year-end figure was almost 5882.3
Discrepancies between forecasts and reality highlight a broader issue. Predictions often rely on linear extrapolation of past trends or assumptions about current conditions, but real-world markets rarely act predictably. Markets react to random events like geopolitical events, natural disasters, economic shocks, or technological breakthroughs, none of which can be predicted by models or experts. Financial markets are extremely complex; a butterfly spreading its wings in one corner of the world could set off a storm in another.
Expertise Isn’t All It’s Cracked Up to Be
University of Pennsylvania professor and renowned psychologist Philip Tetlock is something of an expert on the efficacy of forecasting. In his most famous work, Expert Political Judgment, he reveals that after analyzing over 28,000 expert forecasts, he found that specialists in their respective fields showed no more success than random guesses when it came to predicting the future. The precision and confidence with which predictions were made typically bore no connection to their accuracy.4 We don’t believe there’s any basis to assume that investment professionals should differ from any other type of experts.
The Impact of Cognitive Biases
All humans are vulnerable to natural cognitive biases. One such bias is called anchoring. This is a kind of cognitive shortcut in which people’s estimates are influenced by arbitrary or irrelevant reference points.
Let’s look at an experiment by psychologists Daniel Kahneman and Amos Tversky, the fathers of behavioral finance.
In their study on anchoring, they set up a “wheel of fortune” rigged to land only on the numbers 10 and 65. After subjects spun the wheel, they were asked to estimate what percentage of countries in the United Nations are in Africa. The average estimate of those who had spun a 10 was 25%, while the average for those who had spun a 65 was 45%. The experiment demonstrated that completely random and irrelevant numbers can have an undue influence on subsequent numerical decisions.5
So what does this mean in terms of Wall Street forecasts? Say a strategist predicts that the S&P 500 will appreciate by 10% this year. Even when investors are aware of the historical performance of market forecasts, their minds may unconsciously gravitate toward that number and influence their actions.
So What’s the Point of Forecasting?
Wall Street is obsessed with forecasting, even though we, and they, know that forecasts are unreliable. So why do strategists spend so much effort on forecasting?
It comes down to marketing. Forecasts aren’t meant to be a literal guide for investors; they’re the starting point for a conversation that they hope will generate trading activity. Forecasts for the S&P 500, bonds, gold, real estate – they’re all intended to frame a discussion that will spur clients to make changes in their portfolios.
Forecasts serve institutional rather than client interests, so don’t let forecasts influence your financial planning.
Actionable Alternatives for Investors
If forecasts are unreliable, where should you turn your focus instead? How can you plan for the future when markets are so unpredictable?
Develop a long-term investment strategy: Building a solid plan and maintaining the discipline to stick to it can be one of the most important things you can do as an investor. Focus on your long-term objectives such as purchasing a home, saving for college, and securing a comfortable retirement. To us, time and the power of compounding are more significant drivers of return than the ability to predict next year’s market trends.
Diversify and rebalance: Rather than chasing results based on forecasts, construct a balanced portfolio that is aligned with your risk tolerance and long-term financial goals. Rebalance your portfolio annually to maintain your desired asset allocation and maintain the discipline to avoid emotionally driven decision making.
Cut out the noise: Most financial news is just noise, a distraction that is not likely to contribute to your long-term success as an investor. Don’t obsess over daily market movements or the latest headlines. Focus on what you can control, such as your savings rate and the investment fees you’re paying.
The Takeaway
When you tune out the noise and look beyond short-term forecasting, you reduce the danger of falling victim to irrational decision making. Financial forecasting is best ignored, not just because it’s inaccurate but because it distracts from the more productive task of crafting a resilient investment strategy. A disciplined focus on what really matters – your long-term strategy – is one of the best ways to pursue your financial goals.
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