No, you still can’t predict the stock market

True story but the names have been changed to protect the now-deceased:

Many moons ago, Alice bought the entire family lotto tickets for Christmas. 

Problem was… Alice was essentially broke. Very little income and the whole family was shocked. How could she afford to do this and, more importantly, why would she spend what precious little money she did have on lottery tickets?

I have a hypothesis about this that is totally unproven but does have a plausible explanation behind it. 

Poor people buy lottery tickets because they are trying to predict the future in their own way… they’re desperate for money, and it’s a very psychologically satisfying feeling to believe that you can buy a ticket out of your current financial troubles. People, in general, want to remain optimistic about their future (which is admirable), but reality constantly hits them over the head with the fact that they just lost a bunch of money in the stock market, that their furnace just broke in the middle of winter, that one of their kids need braces and meanwhile they just got a hospital bill for $10,000 for their newborn… and so on. 

What else are these folks supposed to do? So… they tend to overestimate the odds of winning on a long-shot. 

Totally understandable, but also a fruitless endeavor. 

Most people won’t win the lottery. And, even those that do eventually blow through all the money and are back where they started. 

People also tend to see historical events as predictive of future events when they’re not. That doesn’t mean causal connections cannot be made, but specific predictions about specific outcomes is near-impossible for the simple reason that human ingenuity is dynamic and largely unpredictable by a single individual and probably not predictable even by a supercomputer.  

Nassim Taleb writes about this idea of using history to predict the future:

*****

“In Pharaonic Egypt … scribes tracked the high-water mark of the Nile and used it as an estimate for a future worst-case scenario. The same can be seen in the Fukushima nuclear reactor, which experienced a catastrophic failure in 2011 when a tsunami struck. It had been built to withstand the worst past historical earthquake, with the builders not imagining much worse – and not thinking that the worst past event had to be a surprise, as it had no precedent.”

*****

It’s simple to predict what happens if the future is less devastating than the past: your planning appears to have worked. But… what happens if the future is worse than the past? If you only prepared for the worst thing that’s already happened, you’ve only prepared for what was already then a surprise event. 

A new surprise event is not going to be the same as the old surprise event. 

But this is how we are all taught to learn and plan for the future… by making decisions based on past experience as a guide. Problem is, when mistakes are unexpected surprises (as is often the case), this is a huge mistake in and of itself. Surprises are… unprecedented. What can you learn from unprecedented events? These are things that have never happened before and… are unlikely to happen again. That doesn’t mean that you won’t have surprises again in life… it just means you will have very different surprises… somewhat unpredictable surprises.

So… what can you learn from the unexpected?

Only that the world is full of surprises. 

Enter, life insurance. 

Life insurance removes a lot of uncertainty from your world because it takes the unknown and transforms it into the known. On an individual level, it’s nearly impossible to predict the future. There are so many things outside of your control that even if you get a few things right, the odds are against you in getting everything right. However, using the Law of Large Numbers, life insurers are able to make extraordinary predictions about life and death through statistical analysis. 

They don’t know exactly who will die or how any one investment of theirs will play out, but… their risk control measures ensure that, statistically, something will shake out and they can use those percentages to make guarantees to everyone. And, since they are dealing in life and death matters, I would argue it’s literally the most important thing a person can choose to focus on when it comes to money.

And the evidence of the insurance company’s success is everywhere. Most of the mutual life insurers in existence today have been in business for well over 150 years. That, in and of itself, isn’t necessarily impressive, but it does give you a window into the past to see how life insurers planned for unexpected events.

Today, life insurers are taking risks they’ve never taken before. And, maybe more importantly, they’re not taking risks that lots of people are taking.

David Lewis

This post brought to you by //The Rogue Agent//. David has been a life insurance agent, and worked with some of the oldest and most respected mutual life insurance companies in the U.S., since 2004. Learn more about him and his business, here.