Light Reading

Are you a good investor? Or, to ask exactly the same question differently, how good are you at predicting the future?

Making an investment decision is no more or less than making a forecast.

The stock market price of a company reflects the collective expectation of thousands of investors about the future profits of that company. If you are to succeed as an investor, you must do a better job than the other market participants of forecasting those profits.

We all want to know the future – and not only in the context of investing. This demand is met by a plethora of pundits expounding on what will happen next. We seldom measure the accuracy of those predictions.

Very few of us can forecast competently. To quote the economist John Kenneth Galbraith, “We have two classes of forecasters: those who don’t know – and those who don’t know they don’t know.”

Of greater concern, we are perpetually overconfident in our ability to predict the future.

The good news is that all investors can sharpen their forecasting skills. An excellent place to start is the book Superforecasting: The Art and Science of Prediction, by Philip Tetlock and Dan Gardner.

Prof. Tetlock, a professor of psychology at the University of Pennsylvania, spent decades studying the accuracy of economic, social and political predictions made by experts. Nearly all the experts had advanced degrees, and half had PhDs. The results were shockingly poor. The expression he used was “roughly as accurate as a dart-throwing chimpanzee.”

Furthermore, there was an inverse correlation between the fame of the forecaster and the accuracy of their prediction. The best-known pundits tended to craft a compelling narrative in a confident manner rather than accept the complexity of the situation. Because we all like simple stories, these people are most in demand – in print or on the screen. They are often wrong. But never in doubt.

After the failure of the U.S. intelligence community to predict the events of Sept. 11, 2001, and the lack of weapons of mass destruction in Iraq in 2003, an American agency called the Intelligence Advanced Research Projects Activity decided to launch a forecasting tournament, open to the public, with a view to improving their own predictive ability.

As part of this program, Prof. Tetlock and a few colleagues launched the Good Judgment Project. This was one of several teams that would compete to make accurate forecasts.

Starting in 2011, the U.S. intelligence agency posed approximately 500 questions about possible economic and political outcomes. The result, over the following four years, was more than a million individual predictions. The accuracy of these forecasts was measured using a Brier score, a scale originally designed for meteorologists.

Prof. Tetlock’s group beat the control group by about 70 per cent. The top 2 per cent in his group were dubbed the Superforecasters.

Prof. Tetlock studied the approach of this elite group and concluded that accurate foresight is a real and measurable skill. Furthermore, it can be learned and cultivated.

How can investors and others improve the accuracy of their predictions?

Look for people who are intellectually curious and highly numerate, and have above-average intelligence.

Even more important than IQ is RQ or rationality quotient, a test established by professor emeritus Keith Stanovich at the University of Toronto. Those with high RQs take an “outside view” and think in terms of probabilities. Most people, including most professional investors, find it hard to think this way.

Investors should also find people who are “actively open-minded.” In other words, they should consider multiple points of view and be slow to assign causality. They also have a growth mindset – they want to work at improving their technique. Prof. Tetlock has said that if he had to reduce superforecasting to a bumper sticker, it would read: “Beliefs are hypotheses to be tested, not treasures to be guarded.”

And they should allow forecasters to work collaboratively in teams.

If you are one of those forecasters, avoid relying on your instinct. Force yourself to fully reflect on the question at hand, and be willing to change your view as facts change.

Predicting the future success of a company is not an easy task. Only a small minority of professional investors beat the market averages, after fees, over any 10-year period.

Perhaps, however, if you follow Prof. Tetlock’s advice, you will be among that illustrious minority. You will be one of the Superinvestors.