Certainty vs. scenarios: All the ways in which we get the future wrong

-By Sunél Veldtman

 

Imagine the scene: The men are standing around the braai talking about the future with Donald Trump as the most powerful president in the world. One by one, they voice their definitive opinion on why he will be “good for the economy” or “bad for world peace”. There are only strong opinions around this braai. Titbits of information from people in the know, CNN and twitter feeds are shared. There is pressure to sound sure of yourself and interesting.

Let’s face it: we do not like uncertainty.

We feel better when experts confidently explain our uncertainty away. It does not matter that the experts get it wrong more than they get it right. It also does not matter that we know the media sell sensation. We still like to believe opinions communicated with authority. It feels like certainty.

This is one of the reasons why the forecasting industry missed Brexit and Trump and financial markets reacted with shock. It could have been excusable after Brexit – but clearly a Trump win was more likely after Brexit and there should have been a higher probability put on that likelihood.

In the weeks before the US election, most polls forecasted a Hillary win. Even respectable forecasters like Nate Silver had a Hillary win as the most probable option. However, a Trump win was not that unlikely, given the large group of undecideds.

Imagine the scene around the braai again. Imagine someone points out that there are a few potential scenarios and starts exploring the permutations. No one likes a commentator who ‘uhms’ and ‘ahs” about different potential outcomes and likelihoods. Despite the fact that everyone knows that he is right, it just doesn’t feel good.

And it’s the same with investments.

Investments are all about probabilities. It is a trade-off between short-term certainty and long-term gain. Investments in equities for example are highly uncertain in the near future but have a higher degree of certainty on beating inflation in the long-term.

It is our role as advisors to talk clients through the degree in which they want to participate in these trade-offs. We can never promise certainty. We undermine our credibility by doing so.

Furthermore, our strategies cannot be surprised by a highly-likely outcome, even if we didn’t believe it to be the most probable. A strong possibility is not a certainty.

I often see financial advice geared to one ‘most probable’ outcome. Often that outcome is an extrapolation of the recent past. Think back to the many pieces of financial advice in 2015 to invest overseas when the rand was reaching new lows daily. That advice was based on a likely outcome, which in turn was largely influenced by events in the most recent past.

In fact, when the rand was trading around R17/USD, it was increasingly statistically less likely for that trend to continue. However, it was very difficult to contemplate even a small likelihood of a significantly stronger currency at that time.

A financial plan should be based on the likelihood of at least a few different scenarios. We have to think of various potential outcomes, attach probabilities and plan for all of them. The painful truth is that as advisers, we cannot promise that all will be rosy in the future. We have to face, with our clients, the painful potential outcomes of some scenarios and discuss the implications upfront.

In the process, we may not sound confident but in the end, we will build credibility.

 

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