By Meir Statman
Predictions on November 7, 2016, the day before voters elected Donald Trump as our next president…
“As the historic 2016 U.S. presidential election approaches, major Wall Street analysts agree that the S&P 500 will likely sell off if Donald Trump wins, and at least hold gains if Hillary Clinton wins.” CNBC
“We believe that if Trump wins, markets are likely to fall further and not bounce back quickly as they did following Brexit, where the United Kingdom voted to leave the EU.” J.P. Morgan
“The S&P 500 could potentially fall 11 to 13 percent if Trump wins the election.” Barclays1
These forecasts and their realization, only a day later, teach us once more that hindsight is much clearer than foresight. Psychologist Baruch Fischhoff wrote, “In hindsight, people consistently exaggerate what could have been anticipated in foresight… People believe that others should have been able to anticipate events much better than was actually the case. They even misremember their own predictions so as to exaggerate in hindsight what they knew in foresight.”2
Good hindsight shortcuts lead us to repeat actions that brought good outcomes and avoid actions that brought bad ones. Hindsight shortcuts can turn into hindsight errors, however, where randomness and luck are prominent, loosening associations between past events and future events and between actions and outcomes.
Fast driving when luck is good gets us faster to our destination, but fast driving when luck is bad gets us a speeding ticket or worse. Hindsight errors can mislead lucky drivers into thinking that fast driving always gets them to their destinations more quickly, and can mislead unlucky drivers into thinking that fast driving always gets them a speeding ticket. Hindsight errors also can mislead lucky traders into thinking that fast trading always gets them to their profit destinations more quickly, and can mislead unlucky traders into thinking that fast trading always inflicts losses.
We protect ourselves against hindsight errors by the steady holding of diversified portfolios…our way of accepting, wisely, that our investment foresight is not as good as our hindsight, and that we should keep our eyes firmly on our financial and life goals.
1Evelyn Cheng, “Wall Street reacts: Here’s what the markets will do after the election,” CNBC Market Insider, Nov. 7, 2016
2Fischhoff, Baruch. “Debiasing,” in Judgment Under Uncertainty: Shortcuts and Biases eds. Daniel Kahneman, Paul Slovic, and Amos Tversky (Cambridge University Press, Cambridge U.K. 1982): 422-444.