How Good Is A Forecast?

Not very good at all.  People like to think they can project the future and I suppose they can for a little while.  Maybe they can estimate where they will have lunch and possibly even what they will have, or who they will have it with.  Even with a 3-hour future, not 100% accurate.

Long projections tend to be wrong.  Everyone who does them knows that, but they still do them.  Why?  Because it allows them to see how variables react over time when combined with other variables.

So why don’t they work?  Because no model has all the variables, often not even a large selection, and no model has them weighted correctly.  Most variables are probabilities not facts and when you combine many probabilities over a long time, the outcomes are chaotic.  

In the models, the environment where the variables exist doesn’t change.  That is not real world. 

Many people are caught up in the precision of the answer.  Having built some models over the years, I can assure you it is easier to get a precise answer than a fuzzy one.  Super-investor Seth Klarman says this, “It is easy to confuse the capability to make precise forecasts with the ability to make accurate ones.”

So why are there so many forecasts, projections and models?  Because people know that models convince people who do not understand that they are guesses. 

Most of the people who create them believe they are important.  Some may be useful if you know enough about the variables and how they were considered in the model.  But, that won’t help you if all you see is the summary finding.  Charlie Munger explains how it goes. “Some of the worst business decisions I have seen came with detailed analysis.  The higher math was false precision.  They do that in business schools, because they’ve got to do something.”  Students know how to do them and they are taught in B-school, so they must be important.  Not exactly evidence of accuracy.

You as an investor or business person or a citizen who is presented with purported truth must take a different approach.  Treat the modeled answer as another variable to consider in your decision. If it conflicts with other things you think you know, the conflict will assign areas for further study.

Market values are like that too.  They are opinion. A big factor in that value opinion is the flawed human perception of value.

The same general advice relates to expert opinion.  Look for more than one.  It is a truism that for every expert, there is an equal and opposite expert.

Plans that matter, like a retirement plan or a business plan, will never be accurate.  The best you can hope for is to narrow them into some circle of high probability.  Retain some flexibility though because the real world has a way of creating unexpected outcomes and new variables to go with them.

Record, review and revise.  The 3Rs of planning success.

Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario.  In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.

Please be in touch if I can help you.  866-285-7772

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2 Responses to How Good Is A Forecast?

  1. Hi Don, how are you now a days? As you know in the past comments I made on post there are times I agree and there are times I don’t. On the matter of how good is a forecast … is achievable when the objective is planned properly and the plan is worked out accordingly. I have many cases I can mention to illustrate that any forecast can be perfectly achieved and one of them which is I believe important to all is planning your journey in life, enjoying the way you live, accomplishing what you have planned and enjoy living to the end; smiling till you breath your last.

    • Hi Eduardo. Good to hear from you. Long general forecasts work if people are persistent, but they must adapt to new situations as they travel through life. Not many end where they intended using the same tools as were planned.

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