Professor James Poterba

MIT economics Prof. James Poterba has conducted very rigorous research on the subject of demographic trends and asset returns. His research examined the relationship between demographic structure and returns on Treasury bills, long-term government bonds, and stocks, using data from the United States, Canada, and the United Kingdom.

What he found?

From his research, Poterba concluded: “The empirical results suggest very little relationship between population age structure and asset returns.”

I bet Poterba wouldn’t make a very good financial advisor. After examining mountains of data from three countries, this non-affirmative conclusion is the best he could come up with? We financial advisors usually do a lot better; we can spit a mountain of conclusions from a figment of our imagination.

Pseudo-knowledge hurts

One of the most successful market prophets of the past decade, Harry Dent, is a demographer. He forecasted that the Dow would be at 40,000 by 2009. Then, this January when that didn’t seem to be happening, he released a book forecasting The Great Depression Ahead and the Dow at 3,800. After the book release, the market went on to rally 60%. No doubt he is very successful: He has made tons of money selling books. How about those poor investors who followed his advice? Go figure.

Knowing what we don’t know helps

Investors crave certainty, but “knowing” for sure that the Dow will climb to 40,000 or drop to 3,800 is the quickest way to lose money. We financial advisors must accept ourselves, and nudge our clients and prospects to accept, that we actually don’t know much about the future. The sooner we do that, the sooner we can focus on things that actually count, such as planning, diversification, and discipline.

(Reposted from my contributions to Morningstar Advisor.)

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