Do You Have "Prediction Addiction"?

You are not alone. And it probably is not your fault. It may be chemical.

"Prediction addiction" was coined by Jason Zweig, a staff writer at Money magazine and the author of a fascinating new book, Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich (Simon & Schuster August 1, 2007).

It is the compulsive desire to try to make sense out of just about everything. Even events that are not predictable. Like the direction of the stock market or the future price of a particular stock or mutual fund.

This addiction is a particularly bad one. Not only are our brains hard-wired to believe we can predict the future and make sense out of random acts, it rewards us for doing so. The brain of someone engaged in this activity experiences the same kind of pleasure that drug addicts get from cocaine or gamblers experience when they enter a casino.

When predicting the unpredictable goes south, as it inevitably will, the neurons in the brain start misfiring, causing panic and anxiety.

Anything less than total confidence in our predictions implies that we have lost control. The brain resists this conclusion. Random events are perceived as the enemy.

Enter the broker. Many reinforce "prediction addiction" by validating the process. Stock picking, market timing, and picking hot mutual fund managers are premised on this ability to predict the unpredictable.

These brokers are to the investor what the drug dealer is to the addict or the casino is to the gambler. No wonder their allure is almost irresistible. Who cares that their much hyped prophetic skills do not exist?

Take a look at the comments on my blogs. They are filled with all kinds of predictions: stagnation, inflation, recession, depression, the further weakening of the dollar, the wisdom of investing in precious metals or foreign currency, the "inevitable" collapse of the domestic economy and of the stock markets. All expressed with great confidence.

The overwhelming evidence is that these events are simply not predictable.

Market timing is the most pernicious example of prediction addiction. We know we should invest in stocks when the markets go up and in cash, treasury bills or bonds when the market is going down. A huge industry is premised on its ability to make these predictions. However, the direction of the markets is not a predictable event.

In a classic study, Professors John Graham at the University of Utah and Campbell Harvey at Duke University analyzed the predictions of over 237 market timing investment newsletters for a 12 year period ending in 1992. By 1992, 94.5 percent of the newsletters had gone out of business.

The authors' conclusion: "There is no evidence that newsletters can time the market."

Benjamin Graham, the author of the investment classic, Security Analysis, and the financial genius who is credited with being the inspiration for Warren Buffet, put it this way:

If I have noticed anything over these 60 years on Wall Street, it is that people do not succeed in forecasting what's going to happen to the stock market.

Yet every day, investors get conned into engaging in this process, aided and abetted by their brokers, financial advisors and the financial media.

So, what's an investor to do?

Recognize the signs of "prediction addiction" and overcome it.

Pursue an investment strategy that does not depend on predicting the unpredictable. I set forth one such strategy in my blog: It's So Easy, Your Broker Could Do It.

Read any of the books written by John Bogle, Burton Malkiel, Larry Swedroe, Bill Bernstein, Mark Hebner, and my book, The Smartest Investment Book You'll Ever Read. While you are at it, pick up a copy of Jason Zweig's new book. It is an excellent read.

Think of us as your support group.

The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein.

Comments

[dadw5boys]

I predict someone with insider info will knock a stock and the price will drop. They will buy a lot of the stock and make a killing when others rush to buy.
You placed the Puts(short sells) on the U.S. Airline Industry and related industries between 9/06/2001 and 9/10/2001 and made nearly $200 billion dollar on 9/11/2001?
Why has it never been investigated?

[realitytrumpsbull]

I predict that there will always be B.S. infomercials on TV telling you to invest in stuff, and that the money will keep ending up
in a safe on somebody's personal island, that's my prediction...

[emerywood]

There are all kinds of predictions, from picking horses at the race track to picking stocks for a quick profit. Predictions can also be wild or very educated and sophisticated. Without prediction, there will be less challenge and a lot less fun in this world.
I think it is also human nature to predict the future. There is and always will be a past, a present and a future. And the future is the most challenging and intriguing.

[StephenSmoliar]

The noun "addiction" runs the gamut from the innocuous to the downright silly. My guess is that it was deliberately planted to sell a book and deserves no more consideration than other book-promotion efforts. Yes, the brain is always trying to find patterns in its sensory experiences. Gerald Edelman calls the process "perceptual categorization" and makes a case (that is definitely worth the read) that our very sense of consciousness is causally dependent on our capacity for perceptual categorization. Thus, it is not a question of whether or not seeing patterns where there are none is an "addictive" behavior, because all of us (at least those of us who are conscious) do it! However, consciousness also endows us with the capacity to REFLECT on those patterns and reason about their attributes in both space and time (such as future consequences). There is a not-partic­ularly-tec­hnical term that captures our failure to exercise that capacity for reflection; it is called "not thinking!"

[cktirumalai]

The wisest investors seem to be in it for the long haul, the opposite of the day-trader.
During my years in academia, I knew people who created a stir in the short-term but crashed in the medium-term. Some stocks are like that. It takes Buffet-like insight to recognize the difference between the long-distance runners and the deceptive dazzlers who begin way in advance but peter out quickly.

[USAisOK]

Does this transcend to 'predictions' of our policies of state, ie. Iraq? Does anyone really know what the outcome, bad or good, will be? Damn near every 'poster' here seems to believe, however I don't see anyone 'betting' the rent on their proposed outcome. I guess it is like playing the lottery, for the price of a ticket you can dream of the possibilities. If we profess absolutes and generalities to our conviction, we can dream just how 'on target' we are in our assessments.

[ImmanuelGoldstein]

I have felt that way about many policies, the Middle East in particular. I am beginning to question the whole concept of 'expertise' in a lot of areas.

[LeoMarvin]

There's an excellent book by Philip Tetlock, titled "Expert Political Judgment: How Good Is It? How Can We Know?" that answers your question and then some. The bottom line is that the more ideologically determined, the more certain, the more dogmatic the pundit and his predictions, the more likely he'll be wrong. Of course that would be fine if the marketplace of punditry treated such inept predictors efficiently. But it doesn't. People want to be entertained, which means emotional engagement, which means dogmatic ideological certainty, right or (usually) wrong.

There's a very good review of this book here: http://www.newyorker.com/archive/2005/12/05/051205crbo_books1

[RDixon]

Before the new catchy phrase "prediction addiction" was coined, we just called it what it was; an addiction to gambling.

The only sure bet is there are no sure bets.

[Crowhaul]

Good point. And, remember, those who invest solely for the purpose of making money are evil... In other words, investment should serve a cause greater than oneself.