Behavioral Finance

Behavioral Finance: A Sneak Peak into OVTLYR’s Approach (Part 2)

Expert Opinions

We love our experts, from the mechanics who fix our cars to the doctors who fix our bodies. Although we can generally rely on experts in favor of novices to solve readily apparent problems (a mechanic could far more efficiently rebuild an engine block than I could), trouble arises if the problem being solved is of a subjective nature (look up a few of your favorite shows on Rotten Tomatoes and see what the critics think of your viewing choices). It’s even worse once we start asking for predictions of the future.

When it comes to the most significant issues – finances, health, etc. – we crave certainty of the future above all else. We expect our experts to provide that certainty, but these expectations are often unmet. CXO Advisory Group conducted a study of nearly 70 well-known financial experts and their forecasts between 2005-2012. The mean and weighted accuracy of over 6,500 total forecasts were both just north of 47%, and less than 40% of these influential and highly respected experts maintained an average accuracy equal to or greater than 50%… less than 2 out of 5 were as good or better than a coin toss. Similar studies on the predictions of large financial institutions rather than individuals have revealed even less appealing outcomes.

This sort of predictive shortcoming transcends industries to varying degrees in which those requiring frequent or crucial (or both) predictions suffer the most. The argument is held by some that alternative motives may drive experts to give an opinion which aligns with their incentives, and this may occur to some small extent. However, according to Johns Hopkins, medical error accounts for over a quarter-million deaths in the U.S. per year, making it the third-leading cause of death. Certainly, there are not 251,000 annual instances – or even a meaningful fraction thereof – in which a doctor kills a patient for their own benefit.

The takeaway is that, although one person may be highly trained and skilled in a given area – far more so than a novice – individuals are simply bad at making predictions.

How does a Group Predict Better than Experts?

The short answer is: no one really knows yet. There are some areas we can explore to help first identify what can lead individuals astray, and how group efforts might mitigate those risks in much the same way diversification of assets can reduce the risk of holding a portfolio.

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