Build An Ark, Don’t Predict The Rain

Proper financial planning is not about predicting rain, but about building arks. Find out how to investment is an important part of financial planning. 
9 June 2020
Build An Ark, Don't Predict The Rain

Proper financial planning is not about predicting rain, but about building arks. Find out how to investment is an important part of financial planning.

My son is named Noah, after the biblical prophet who built an ark out of faith. One of Warren Buffett’s lesser-known quotes is based on Noah’s story: “Predicting the rain doesn’t count; building arks does.” Buffett was giving advice about running businesses, but the same applies to investing and financial planning.

Many active investment managers and investment advisers spend an inordinate amount of time, effort, and client fees honing their weather prediction skills. They use macro analysis, valuations, and/or technicals and build models, to help them adjust their clients’ portfolios “nimbly” and “dynamically” to get out of impending storms and get back into the sunshine.

But investing is not putting out your laundry. It is not a simple matter of re-doing the washing if your advisers’ predictions turn out wrong. You risk not being able to lead the life you want if you take the wrong actions on the basis of these predictions. If your adviser or fund manager had reduced equities for you when markets were plunging towards -30% from a peak earlier this year, he would have turned your portfolio’s temporary decline into a real, permanent loss. Today, global stock markets have rebounded strongly from their lows. Once again, the weather forecasters are out. The common refrains are that valuations are too high, the stock market has moved ahead of the economy (it always does!), there might be a second wave of the pandemic and thus a second storm.

I am not saying that we will not have a second dip in the market in the near future. In fact, just on 11 June, we have a big drop of almost 6% in the US S&P500 index overnight, after a strong upward climb over the last few weeks.  But such is the nature of the stock market – it fluctuates in the short term, sometimes wildly, because of uncertainty. The main point is that we must see the woods and not the trees. Taking action on the basis of such short-term predictions, or allowing “professionals” to do so for you, is futile and dangerous for two reasons. First, the track record of active fund managers in forecasting and timing the market is dismal. Most fund managers fail to beat the market in any time frame and those who do, cannot do so consistently. Second, if the active predictions are wrong, you risk making a return that is far lower than the average market return which you would have earned if you had stayed invested through the ups and downs. This lower return might mean that you do not have enough assets to live the life you want. Take a look at the chart below. You may have seen it before in my letters; I bring it up again because it illustrates such an important point.  Even missing just 25 best single days of return in 20+ years, which can happen if you move in and out of markets on the back of predictions, can cause your annualised compound return to halve. So before you wager your retirement plan on your favourite analyst’s forecast against the market, think again!

Reacting Can Hurt Performance
Source: Dimensional Fund Advisors

Proper financial planning is not about predicting rain, but about building arks. At MoneyOwl, we like to say that comprehensive financial planning is about reaching your life goals, no matter what happens, in as comfortable a manner as possible. Sticking to your plan is essential. There really is no need to take such an active fund manager risk on your life goals.  Even if a second downturn comes, the global stock market will still recover and go up in the long term. You will be fine as long as you have the time to stay invested and you are invested in the whole market (not individual stocks or individual countries) through a broadly diversified portfolio. At the same time, a good financial plan, by definition, must be holistic and comprehensive and go beyond investments, which are only one part of your financial life. Because nobody has unlimited resources, your decisions on investments will always affect other parts, and thus the overall strength of your financial plan.

The prophet Noah is known to have been a man of faith for two reasons. First, he believed God that while there would be a huge storm, there would also afterward be renewal, life, and growth on earth. Second, he acted on his belief by taking action to build the ark over decades, instead of looking for signs in the skies for when the rains would come before he started. He knew that building an ark took time. The story ends with Noah, his family, and every species on earth preserved and a beautiful rainbow in the sky.

May I encourage you to similarly put your faith not in predictions, but in the concrete action of doing a comprehensive financial plan today, so that you and your family can also reach the rainbows of your hopes and dreams, come what may (or when) in between.

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