Irving Fisher, one of America’s most celebrated economists, famously, and disastrously, stated that stocks had reached a “permanently high plateau.” He had the unfortunate timing of doing this right before the economic collapse of the great depression.

On occasion, very smart people will follow in Fisher’s footsteps when they proclaim something about the future with certainty. Perhaps financial advisors and the companies that they work for feel that clients expect them to have some sort of opinion on the direction of the market. Part of it, may stem from the belief that clients are paying their financial advisor so that they will somehow “beat the market.” This hope often isn’t realized.

While there are many opinions that one can have about the future direction of market movements, perhaps there is only one statement truly worth standing by: “I don’t know what will happen next.”

Market fluctuations are impossible to predict in the short run

As Irving Fisher’s comment suggest, even the brightest minds can be way off target. In his book, A Random Walk Down Wall Street, Burton Malkiel characterizes the short term variation in pricing of tradeable investments as (you guessed it), a “random walk.” What does this mean? It means that the market appears to move randomly without any pattern or inefficiency that we can chart out or capture in order to thereby “beat the market.”

This inability to predict the short-term movements and fluctuations of the market supports the prevailing superiority of “passive” index fund investing over active management. In other words, the data suggests, at least for now, that you’re generally better off trying to capture market returns through the purchase of broadly diversified index funds, than paying extra to fund managers who try to find investments that are going to outperform the market.

The Efficient Market Hypothesis

If you’re new to investing, or come from the school of active management, all of this might feel a little strange. And it begs the following question: “Why can’t a good fund manager or my financial advisor beat the market?” The answer is that a fund manager (or your financial advisor) may, in fact, beat the market on occasion. But it’s not the single year play that we’re thinking about. It’s the long-term statistical probability of any individual or company beating the market consistently.

There will be some that do it. The trouble is this: Was it luck or skill? So far, it appears that most of the time it has been luck. And if there are those that skillfully beat the market, there isn’t a reliable way to determine who they will be beforehand.

Eugene Fama, the American economist and recipient of the Nobel Prize in Economic Sciences, is the father of the Efficient Market Hypothesis. In simple terms, the efficient market hypothesis is a theory that the market responds to new information quickly and efficiently, thereby making it impossible (or at least very difficult) to find inefficiencies to exploit and thereby “beat the market.” There are varying levels of agreement with this theory, and it’s quite controversial in modern finance.

Notwithstanding, there is merit to looking at the investment world through the lens of the Efficient Market Hypothesis. For example, the difficulty of beating the market on a consistent basis makes it practically impossible. And again, even if someone did do it, how would we identify that person beforehand? And how would we determine whether their outperformance was because of superior smarts, or simply dumb luck?

Better to admit that we don’t know with certainty which direction the market is going to go in the short run. And for what it’s worth, neither does anyone else.

If I can’t predict the future with certainty, what should I do?

If market fluctuations are impossible to predict in the short run with any real accuracy, what should you do about it? I have a few thoughts:

1. When you invest “in the market,” remember that you are investing in actual companies. It’s possible, and even likely, that some of those companies will fail for one reason or another. If you have too much of your investment holdings in that company, it’s going to hurt. The flip side of this is that if you spread out your investment holdings over enough companies, one bad apple won’t ruin the whole bunch.
2. Invest for the long haul. While there are no guarantees in life, investors have historically been rewarded for sticking out the ups and downs of market performance over a long period of time.
3. Invest in globally diversified index mutual funds and ETFs. Yes, invest “passively.” If you agree that short-term market fluctuations can’t be predicted consistently, then you see that it’s not very helpful to spend time trying to find the next “hot” investment.
4. Focus on what you can control. Because we can’t consistently predict where the market is going in the short run, we ought to focus on things that we have greater influence and control over. For example, focus on keeping your investment costs low. Again, index funds can be very helpful here. As a start, check out your investment funds’ expense ratios.

Some Final Thoughts

Perhaps this article comes as a surprise. Perhaps it doesn’t. The truth of the matter is that no one really knows what is going to happen in the short run. And in the long run, we are simply hoping for the best. This might sound like there isn’t much that a good financial planner can do to help, but that isn’t actually the case. For example, they can help you align your investments with your risk tolerance, guide you in selecting cost and tax-efficient funds to invest in, assist you in establishing a solid insurance plan, and help you design a retirement income strategy (just to name a few).

But the next time you hear an advisor, media commentator, or some other “expert,” start to expound on their predictions about the direction of the market, plug your ears and imagine them saying, “I don’t know what’s going to happen next” over and over and over again.

Disclaimer:

This content is for informational purposes only and should not be construed as personalized advice. Your unique situation needs to be considered, and the ideas presented here may not apply.

Please be sure to do your due diligence BEFORE implementing anything. Due diligence may include hiring a qualified professional who understands your situation completely and can offer you personalized advice.