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Why are forecasts bad for you and your money?

The Great Indian Election Tamasha is over. We too are excited about the prospect of political stability, but are shocked at what a bad job all the forecasters did of predicting the overall winner and the margin of victory. Now the finance world is full of forecasts, usually not backed up by adequate thought or research. We wanted to use this opportunity to explain to you why forecasts are bad for your money and why you should not substitute your own thinking for the forecasts of others.

What the 2009 General Elections demonstrate about forecasts?
Give me examples of financial forecasts that have been wrong?
What does this have to do with my money?
What should I think about when someone makes a forecast?
What are common forecasts I should watch out for?

Watch the video

Basically, that its very hard to predict the future. In advance of the 2009 Elections no one predicted that the ruling party would have its best performance since the 1991 Elections and would have such a positive outcome. In fact, even the exit polls right after the election days got it dramatically wrong.

In short, despite the best efforts of some of the best researchers in the country, their forecasts were wrong. So, in this context you really have to question why you would ever believe forecasts again, and especially when it comes to what to do with your money.

Here are two of them for you:

1. When the Sensex was at approximately 21,000 points the consensus forecast was for it to go up even further. Within less than a year we had hit as low as approximately 8,000 points
2. When our economy was growing at 9% Government statistics and economists still predicted that we would grow at this high rate in the coming year. A few quarters later, this forecast was reduced to around 6%

That forecasting is difficult is seen in almost every sphere of life, be it elections or finance. For instance, how many of us predicted that the Rajastan Royals would win the inaugural season of the IPL in 2008? Everyone thought it would a big city team from Mumbai or Kolkata with more expensive and reputed players.

Hopefully, by now you are getting the message that forecasting is difficult and believing in forecasts has its own risks.

A lot! Finance is an area where forecasts are plenty. Every day on TV and in the papers you see someone making a prediction about stock prices, real estate prices, commodity prices, interest rates etc. going up or down. If you do agree that predicting the future is hard then why do you believe the forecasts of these so-called experts?

In fact most of these experts have a poor track record of getting their forecasts right. Would you keep going to a Doctor whose track record of success is very poor? Then why listen to a financial forecaster whose track record is poor? You have a decent chance that you will end up losing money.

Many of these expert forecasters might have a hidden agenda to pump up the interest in a particular type of asset or company. Before you invest on the forecast of some expert, understand whether you are investing blindly based on the forecast of someone or whether you genuinely understand what you are doing.

• Why is this person making a forecast - is there a hidden agenda to drive the price up or down
• If this person knows the secret to making money, why is he/she so willing to share it with me, why not keep it a secret
• Is the forecast backed up by solid research and what has been the track record of this forecaster
• What kind of margin of error can you live with if the forecast is wrong
• What kind of independent thinking should you be doing in addition to using the forecast

Here are some forecasts and predictions that you should watch out for:

• "This ULIP insurance will double your money in a short time."
• "Nobody loses money on real estate - this project will give you high returns and will have lots of buyers."
• "The stock market cannot go down, its safe to invest now."

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