Our purpose is not to criticize, but rather to help investors understand the role forecasting should or should not play in their investment decision making process.
It Is Dangerous To Trust Expert Forecasts
To illustrate the dangers of trusting your retirement and net worth to expert forecasts, let’s assume the following:
- In December 2007, a 54-year old investor is one year away from retirement.
- The investor has a $2M portfolio of which 60% is allocated to an S&P 500 Index heading into 2008. A 60% allocation to stocks comes to $1.2M.
- The investor is working with one of the eight major firms that had their 2008 S&P 500 forecast published in USA Today on January 2, 2008.
The purpose of this hypothetical example is to illustrate what an investor expected to have from an income-generating perspective in retirement and what they had in the real world as of December 31, 2008, or one year later when they were ready to retire. If they were working with one of the major firms, their expectation was to earn roughly 10% on their $1.2M in the S&P 500 in 2008 (see green column below). Their actual return was a loss of 38% (red column).
Impact On Income Producing Principal
If we take the hypothetical example a bit further, we can estimate the negative impact on income during retirement. The table below shows the projected growth of $1.2M versus the actual growth in 2008. The most important column is shown in orange; it represents the shortfall of forecasted expectations versus real world performance. For example, in the first row, moving left to right, the investor expected their $1,200,000 stock portfolio to be worth $1,393,227 at the end of the year based on their major firm’s 2008 forecast. Still moving left to right in the first row of the table, in the real world their $1,200,000 was worth only $748,860 at the end of 2008, which represents a shortfall of $644,368 relative to forecasted expectations.
Impact On Annual Retirement Income
If we assume our 55-year old planned to convert the S&P 500 portion of his/her portfolio into an income-producing diversified mix of investments that generate 4% annually, the table below shows the income they expected to have on January 2, 2008 that they did not have as of December 31. 2008.