Future Babble: The Best Experts Know What They Don’t Know

What happens next? is probably the most asked question in human history. People hate uncertainty and yet uncertainty is all around us. We want to know that everything will be okay.  It is this natural yearning to know the future that has created a immensely profitable industry for so-called “experts.” Experts are learned people who have spent many years in school (including the school of hard knocks) and supposedly have a better understanding of how the world works – and will work. In our own lives, we are acutely aware of our inability to predict the future, but the yearning remains. We want to believe that the future can be predicted so badly that we are willing to suspend reason and latch on to virtually anyone that says they can do it. As entrepreneurial coach Dan Sullivan puts it:

People want, first, a sense of direction … a path that guarantees they’ll be all right. Second, they want confidence. They’re lonely. They feel isolated.

In fact, the bigger and more outrageous the claim of clairvoyance, the more we are prone to believe it.

Don’t believe it.

Most Experts Are No Better Than Chimpanzees

According to Dan Gardner, author the recent book Future Babble: Why Expert Predictions Are Next to Worthless, and You Can Do Better, the predictions of experts are no better than random guesses! He discusses an academic study by Wharton professor of psychology Philip Tetlock, which measured the accuracy of 27,450 predictions made by 284 experts over several years. The study concluded that the experts’ accuracy was no better than a dart-throwing chimpanzee. Although Gardner’s book concludes that experts – as a whole — are worthless, he also observes that some experts were much better at prediction than others. This is the takeaway from his book that interests me the most. Specifically, he wrote that the key to success is process, not pedigree:

What distinguishes the impressive few from the borderline delusional is not whether they’re liberal or conservative, optimists or pessimists, or whether they have a doctorate, extensive experience, or access to classified information. Rather, it’s how they think.

Experts who did particularly badly – meaning they would have improved their results if they had flipped a coin through the whole exercise – were not comfortable with complexity and uncertainty. They sought to “reduce the problem to some core theoretical theme, and they used that theme over and over, like a template, to stamp out predictions. These experts were also more confident than others that their predictions were accurate. Why wouldn’t they be? They were sure their One Big Idea was right and so the predictions they stamped out with that idea must be, too.

Experts who did better than the average of the group – and better than random guessing – thought very differently. They had no template. Instead, they drew information and ideas from multiple sources and sought to synthesize it. They were self-critical, always questioning whether what they believed to be true really was. And when they were shown that they had made mistakes, they didn’t try to minimize, hedge, or evade. They simply acknowledged they were wrong and adjusted their thinking accordingly. Most of all, these experts were comfortable seeing the world as complex and uncertain – so comfortable that they tended to doubt the ability of anyone to predict the future. That resulted in a paradox: The experts who were more accurate than others tended to be much less confident that they were right.

When you’re less confident, you’re more likely to make less precise predictions and less precise predictions have a greater likelihood of being accurate. For example, if you are a stock analyst and are bullish on a stock, it’s better to take a long-term view and predict that the stock will be outperform the S&P 500 by some indeterminate amount over the next three years than it is to predict that the stock will rise exactly $10 in the next two weeks.

The importance of knowing what you don’t know is not a new concept. The 19th century American author and humorist Mark Twain once said: “It’s not what you don’t know that gets you into trouble. It’s what you know for certain that just ain’t true.”

Two Types of Investors

Oaktree Capital Chairman Howard Marks — a billionaire and superstar investor — delivered an excellent speech at a 2011 Value Investing Congress called The Human Side of Investing. In his remarks, he stated that there are two types of investors, one of which is much more successful than the other:

I divide investors into two schools: The “I know” school and the “I don’t know” school. For my first 20 years in business in what I would call the institutional establishment, I ran into the “I know” school most of the time. These are people who will tell you exactly what is going to go on one, three, five, or 10 years from now in the economy, in the markets, in interest rates, which economies will do best, which industries, and which stocks. They tend to invest on the assumption that they are right. Then when they turn out to be wrong, they try to correct their mistakes and invest on the next set of scenarios rather than acknowledging that perhaps rightly there are limitations on their foreknowledge. The “I know” school invests for one outcome, economy, market, interest rates, industry, and company. They concentrate their portfolios given that they know what the future holds. They lever heavily, and they target maximum price gains.

Most of the outstanding investors that I have known over the years belong to the “I don’t know” school with regard to the macro environment. They may know companies and securities better than anybody else in the world, but with regard to the macro they assume that they don’t know what the future holds. So they hedge against uncertainty. They diversify. They avoid or limit leverage, and they emphasize the avoidance of losses rather than the acquisition of gains.

When most people think about the future, they ignore that the future is a distribution of possibilities. If you are a student, and you know what is more likely than something else, you might think about the future as a distribution of probabilities if you can wisely assign probability. But it is a range of events that could happen. Most people – especially in the “I know” school – think in terms of the average or the norm, and think that the thing they think is most likely to happen will happen and they ignore the outliers.

One of my favorite adages is this one: Never forget the six-foot tall man who drowned crossing the river that was five feet deep on average. The important thing to remember about investing is that it is not sufficient to set up a portfolio that will survive on average. The key is to survive at the low ends.

Temet Nosce

Investing Daily’s David Dittman has written about the importance of knowing yourself (“Temet Nosce” in Latin). In his article, Mr. Dittman discusses the importance of humility and temperament to great value investors such as Warren Buffett and his mentor Ben Graham. In addition, I’ve talked about the importance of humility to the investment process several times, including:

Bottom line: When choosing a financial advisor, look for the advisor who is humble, risk-averse, and speaks in terms of probabilities rather than predictions. In other words, the exact opposite of what you see on CNBC.

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