As someone with a degree in Economics, I have heard a certain truism a million times: Weather forecasters and economists are the only ones who can be wrong all the time and keep their jobs.
Sure, it’s kind of funny and feels like it may be true. But, there are a few realities about how predictions work and how the human brain interprets them that make people very bad at understanding predictions. So, in essence, it is not the meteorologists fault that you think their forecast is wrong. It’s almost always your fault for misinterpreting the probabilities inside the prediction.
I know, that sounds crazy, but hear me out.
Predictions are Based on Probabilities
According to BiologyOnline.com, a prediction is an educated guess, based on previously found information, about a future outcome.
An “educated guess” means that the outcome is not known, yet. It is uncertain.
Scientists of all disciplines make those educated guesses by determining the probabilities of different outcomes based on evidence they have collected about similar circumstances.
That’s how weather models work. Meteorologists gather data from weather stations all over and use fancy math to determine how likely recent conditions are to produce certain outcomes. They may use different words when they broadcast the weather, but it can be interpreted as “pretty much every time this happened before, we had some rain… so we’ll probably get some rain this time too.”
Now that we have lots of weather stations and lots of historical data, meteorologists can get more precise than that. They can say, “based on tons of historical data I can use our current conditions to predict that there is a 70% chance of rain tomorrow.”
People Are Bad at Probabilities
But, that creates a problem. People are really bad at interpreting probabilities.
There have been tons of studies that show that people are horrible at understanding how probabilities work. (like this one from the University of Toronto).
For example, the odds of winning the Powerball are 1 in nearly 300 million. Which is the same as a 0.0000003% chance of winning. Which is the same as a 99.9999997% chance of losing. But, many people play because they might win.
And yet, when a weather forecast says there is a 70% chance of rain tomorrow, but it ends up not raining, a lot of folks will say that the forecast was “wrong.”
Sorry, no. It wasn’t wrong, you just weren’t paying attention.
The forecast said that 70% of the times that similar conditions existed in the past, it rained. But 30% of the times that we had these conditions it didn’t rain. So, there was a 30% chance that it might not rain. Which is 90 million times more likely than the odds of winning the Powerball.
Playing the Powerball because you might win but saying that a forecaster is wrong if it doesn’t rain when there was a 30% chance of dry conditions is a bit hard to swallow.
Use the Predicted Range and You Will Almost Always be Right
So, what should we do?
When it comes to predicting rain, there are only two potential scenarios: it will rain or it won’t. Without a meteorologist to tell you whether it will rain tomorrow or not, you should be prepared for the entire range of rain scenarios. If it rains, you’ll need an umbrella. If it doesn’t rain, you won’t. So, by taking an umbrella, you are prepared for both scenarios.
The same is true of economic and market forecasts. If you listen carefully to economic forecasts, they are almost always given as probabilities. They will say that the chance of a recession has increased or decreased. A stock market correction may become more or less likely. No good economist will ever say “there will be a recession next year,” or “the stock market will recover next week.”
However, good economists will say things like, “this economic expansion has lasted longer than any other in the history of the United States, therefore, the longer it continues, the more likely it is to end.”
As a result, we know that economic booms and busts happen. Sometimes huge sections of the population become unemployed for reasons beyond their control. We know that the stock market goes up and the stock market goes down. Over long periods of time the general trend is upward, and long-term investing generally beats inflation. But, sometimes there are bad times that drag on and on. So it makes sense to set up our finances to both survive and flourish in all possible future scenarios.
There will be another recession. We just don’t know when.
There will be another economic boom. We just don’t know when.
The stock market will crash again. We just don’t know when.
The stock market will go up again. We just don’t know when.
What this Means for your Finances
So, what should you do with your finances based on all of this?
Ignore all economic predictions. Instead you should:
- Spend less than you make
- Have emergency savings
- Have some investments that do well in all market conditions
- Rebalance regularly
Economic booms and busts come and go. Make sure that you are set up to survive and flourish during the next boom and the next bust. That way, no matter when it happens, you will be ready for it.
Check out my Undetailed Budget to learn how to spend less than you make.
See my article on how to Survive an Income Crisis to learn how to pile up cash.
And, check out my approach on how to Use Diversification to profit from all market conditions.
Trying to predict just about anything is super hard. Scientists who are in the business of making predictions go to school for years to learn incredibly advanced math to help them figure it out.
The result of all of this math is a series of probabilities. But, unfortunately people are notoriously bad at interpreting probabilities.
So, instead of chasing predictions and being constantly disappointed, I prefer to focus on what I can control. There is a range of possible outcomes, but I will be better off tomorrow than I am today, no matter which outcome actually happens.
That’s because I spend less than I make, I have emergency savings, I have diverse investments, and I rebalance regularly.
I hope this has been helpful! I welcome your comments with your thoughts and questions. And, don’t forget to subscribe to the newsletter to get notified whenever a new article is posted.