Seeking Alpha
Bonds, dividend investing, ETF investing, currencies
Profile| Send Message|
( followers)  

I don't often disagree with the very smart Carl Richards, but I did take issue with a piece that was sent to me titled "investment plans and forecasts don't mix". Carl says it's silly to construct a forecast of any type or listen to anyone who makes forecasts. Now, I think it's important to be very clear about this point so that when we construct portfolios we know precisely what we're doing. And make no mistake - when you construct a portfolio you are ALWAYS making a forecast whether you use someone else's forecast or your own implicit forecast.

First, let me say that there's a lot to like about the concept of "passive investing". The idea that you should reduce fees and take your behavioral biases out of the equation are two of the most important things any investor can do. But the concept of passive investing is often sold using the mantra that it's "forecast free". This is simply wrong. Here's why.

When you take a position in the market you are always making a forecast of some type. If you're a long only equity owner who uses a buy and hold portfolio, then you are making an ultra bullish forecast about stocks over the long term. If you implement a multi-asset class portfolio with some hedging involved, then you're almost certainly taking an equity bias which results in a bullish forecast (though probably less bullish than the long only equity portfolio). Your portfolio is almost guaranteed to have a directional bias and that means that it has a specific forecast tilt built into it. This means you're making a specific bet on a specific economic/market trend which means you are indeed making a forecast about the future.

It's very important to be clear about this. There is no such thing as constructing a portfolio without some directional bias. Even a perfectly hedged portfolio has a slightly negative after friction bias. But most of us construct portfolios with a long equity bias which means we are implicitly bullish on stocks and the economy. And so our forecast, whether we know it or not, is actually a bullish one. This is generally a very good bet, but you should know what you're doing when you're constructing a portfolio of any type. Going into it saying "I don't make forecasts" is a dangerously naive view of the world and could expose you to unforeseen risks.

It's okay to make forecasts. It's okay to make very bullish forecasts. And it's often dangerous to listen to pundit forecasts because it could lead you to shift your portfolio like a hot potato. But know what you're doing before you do it so your portfolio can actually be designed in a manner consistent with your personal needs and goals. Go into the portfolio construction process with your eyes wide open or you might find yourself in a bad place one day not knowing how you got there.

Source: Investment Plans Are Always Forecasts