Tune out the noise

The demand for financial forecasts continues, but Simon Bruce explains why senior doctors should simply ignore the noise

Tune out the noiseThis time of the year always brings the seasonal ritual of economic predictions for what may lie ahead, but few of the forecasters admit that their calculations for the year before turned out to be little more than educated guesswork.

As we see year in, year out, the one certainty is that many predictions will be wrong.

How many times did you hear that interest rates would ‘definitely’ rise in 2014? Or 2013, for that matter?

While these economic forecasts can make entertaining reading, acting upon the information can be a more serious issue. Investors who try to beat the market by moving stocks ahead of a perceived negative or positive event can fare far worse than if they had simply ignored the noise.

No time to panic

This time last year, Citigroup predicted the FTSE100 would reach 8,000 in 2014. Although it did nearly achieve its 6,930 dotcom record from 1999, such large-scale forecasts were typically wide of the mark.

Despite these previous over-optimistic claims, the same strategists are now predicting that the index will rise to 7,700 this year.

In September last year, the FTSE100 hit a peak of 6,904.86 points, its highest level since 2000. By October, however, the financial press was gloomily reporting substantial falls of around 10%.

The largest one-day rise (9.8%) for the FTSE100 came on 24 November 2008 – incidentally this came after the US government rescued ailing Citigroup. Yet this was also the year the index suffered its biggest annual fall – some 31%. Seasoned investors are all too familiar with these roller-coasters.

Predicting how markets and economies might react at any given time is impossible – despite those New Year articles you, no doubt, saw last month. There is some truth in the joke: ‘economists have successfully predicted nine out of the last five recessions’.

Investment behaviour

The main concern is that the forecasts are often overly optimistic or pessimistic, which can lead investors to cause more harm to their own investments than the market itself.

Rash decisions can mean selling at the bottom – the opposite of best investment practice – and then missing the subsequent rebound.

In all three of Britain’s recessions since the Second World War, the markets have rallied strongly the following year, rising by 142% cent in 1975, 29% in 1982 and 20.7% in 1991.

Research material which charts the rise and fall of the stock market every year between 1986 and 2013 reveals the maximum losses investors could have made by buying at the year’s highest point and selling at its lowest.

In 21 of the 28 years, buying and selling at the wrong times would have accounted for double-digit losses. Interestingly, in only seven years did the market end lower than it began.

We have seen time and again that, at the exact moment investors decide to take flight from a market, the stocks flourish. But holding your nerve during such significant fluctuations can be easier said than done.

There is much evidence to suggest that our own reaction to the flux of the economy could be our worst enemy. Nobel Prize winners Daniel Kahneman and Amos Tversky reported that investors feel the fear of losses twice as much as the pleasure of the same amount of gains.

They also tend to analyse investments too frequently and over too short time-frames. The combination of these two factors has been named ‘myopic loss aversion’ and can make it difficult for investors to stay focused in the face of volatility.

As John Bogle, founder of mutual funds company Vanguard, said: ‘If I have learned anything from my 52 years in this marvellous field, it is that, for a given individual or institution, the emotions of investing have destroyed far more potential investment returns than the economics of investing have ever dreamed of destroying.’

Has Buffett got it wrong too?

Even the ubiquitous Warren Buffett has failed to follow his own philosophy. Last year, in the midst of Tesco’s annus horribilis, the investor offloaded 245m shares in the company when the share price was down by more than 50% in the year.

In doing so, he turned his paper losses into millions of pounds of real losses – he who advised investors to ‘get greedy when others are fearful and fearful when others are greedy’.

Financial fire drill

Rather than trying to anticipate what might happen tomorrow, the prudent option is to look at what might transpire over the course of your investment plan. Are your finances well organised and in a secure environment that can handle the ebb and flow of the markets?

Good financial advisers will ensure their clients have the right expectations before any market decline, but encourage discipline throughout the downturn.

They may conduct an investor’s fire drill. This means they make sure clients are in the safest position over the long term and that they know not to panic when the next piece of negative economic news hits the media, because their portfolio has been designed to account for challenging times.

After all, global markets have always recovered and, over time, markets will take a middle course – but that does not create such strong headlines.

Simon Bruce (right) is managing director of Cavendish Medical, specialist financial planners helping consultants in private practice and the NHS

The content of this article is for information only and must not be con­sidered as finan­cial advice. Caven­dish Medical always recom­mends that you seek independent financial advice before making any finan­cial decisions. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circum­stances of the investor. The value of invest­ments and the income from them can fluctuate and investors may get back less than the amount invested.