Tsunamis, Nukes, and Uprisings: Why Smart Investors Don’t Predict

This year has been full of the unexpected. The world is an unpredictable place. It was just a few weeks ago that Egypt and then Libya dominated the airwaves. Now they are distant memories with the horrific events in Japan this week. Who would have thought that an earthquake would lead to a nuclear meltdown? Who would have predicted that Arab dictatorships would topple because of Facebook and Twitter? What is an investor to do?

The answer lies in whether your investment focus is based upon predicting or positioning.

It’s a lot more fun to invest based upon predictions. Jim Cramer and pundits interviewed on CNBC are highly entertaining. They tell us with utmost certainty what will happen with a company, a sector, or an economy. And they know how to provoke our fear and greed so we’ll keep watching.

Most everyday investors only know an investment world based on predictions. They’ve heard about the mutual fund manager who finds undervalued companies by predicting cash flows, the Merrill Lynch broker who calls with his analyst’s latest tip, the Motley Fool newsletters, or the UBS economist who predicts a drop in the U.S. dollar.

But most of us are still smarting over our damaged portfolios from the 2008 financial meltdown that the forecasters failed to predict.

Another group of investors—institutional investors such as pensions, endowments, and foundations—believe that predicting the future is at best informed fortune telling. After decades of research and experience, they’ve concluded it’s better to focus on being positioned, instead of attempting to predict what will happen in the world. They know there are risks that can’t be articulated or imagined, let alone predicted. So they endeavor to build portfolios to withstand the unexpected.

Most of these institutional investors have fully recovered from the 2008 meltdown. They didn’t sell stocks in March 2009 in a panic—they bought them. What can we learn from them?

First, these investors face sobering tasks. Pension plans have to send checks to retirees every month. Managers at university endowments have to help pay scholarships and faculty salaries. They want a portfolio with a variety of assets that behaves differently depending upon any scenario. They reason through allocations to U.S. stocks, treasuries, foreign stocks, real estate, or commodities. When the world panics, investors flock to treasuries. When inflation worries are front and center, commodities and real estate benefit at the expense of treasuries.

They debate these issues and end up with a policy that can only be changed by committee. Once they agree on the policy, they look for the best ways to “get exposure” to each type of asset. They focus on fees. They only hire managers if they feel they can get outperformance, otherwise they buy index funds. They don’t care about Netflix or Apple. They care about whether they have the right allocation to U.S. growth stocks. And when the markets have big changes and the actual percentages differ from their recipe, they don’t panic. They don’t change the policy. They rebalance back to the policy. These investors are buying Japanese companies this week, probably because their allocations have changed since the panic there.

There is a quiet but growing revolution going on in American retirement investing. Baby-boomers need to retire and they don’t have enough. They’ve grown weary of expensive predictions. They want to be positioned. Earthquakes, tsunamis, and revolts become stress tests for how well a portfolio is positioned. Was your portfolio well-positioned over the last six weeks? Are you trying to predict what will happen next? Think about positioning, not predicting, and manage your family money like the smart guys.