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Helping Larchmont Families Plan for the Future
Ian A. Post, CFA
Fifth Set Investment Advisors LLC • 2065 Boston Post Road • Suite 200 • Larchmont, NY 10538
Email: ipost@fifthsetinvestment.com • Web: www.fifthsetinvestment.com • Phone: 646-783-9717
• Portfolio Management
• Financial Planning
• Investment Insights
Investment Corner
IanA.Post,CFA
“The Prediction Paradox: the more
humility we have about our ability to
make predictions, the more successful we
can be in planning for the future.”1
The results of the presidential election made
some people happy and some sad but most
everyone was surprised. I personally was ob-
sessed over the last few months with election
polls, models and predictions.
One of the models I followed closely was
fivethirtyeight.com, a website developed by
Nate Silver, a statistician who specializes in
forecasting sporting events and elections.
While he didn’t outright predict a Trump win,
he made a strong case that Trump could2
win.
What Silver and his model successfully incor-
porated was an appreciation of uncertainty3
.
So, what can we learn from pre-election polls
that seemed to assure a Clinton victory that
can help us manage our investments?
Most people are familiar with the historical
average return on stocks of about 12%4
. But
what is the likelihood of a 12% return in any
particular year? How shocking would it be if
stocks lost 20% or more?
Let’s look at some history. We have a total of
ninety calendar year returns for the S&P 500
beginning in 1926. Out of those, how many
would have met expectations assuming we
always expect a 12% return?
A grand total of three5
!
In only three calendar years, or roughly 3%
of the time, did equity returns match the 12%
expectation. How often have we had losses
of 20% or more? That also has been a fairly
rare event with only six calendar year returns
of 20% or greater losses. How about losses of
any size? The S&P 500 has delivered negative
returns 24 times since 1926 or slightly more
than 25% of the time.
Thinking about future stock returns as a range
of possible outcomes can help us appreciate
investment uncertainty. Assume we knew
for certain that the mean expected return for
stocks was 12%; we would still be faced with a
very wide range of possible “normal” returns.
Since 1926, the standard deviation6
of S&P
500 returns is 20%. Using that information, we
can say that about two-thirds of the time, we
should expect a return in the range of plus or
minus 20% from the mean or -8% to 32%. The
range covering 95% of annual returns is -28%
to 52% and for 99% of annual returns, the
range is -48% to 72%. Amazingly, even these
ranges underestimate the true uncertainty
because 1) we don’t know the expected mean
return going forward and 2) stock returns are
not normally distributed7
.
So, what to do with all this uncertainty? First,
take a step back and accept that we simply
can’t make accurate single number predic-
tions about stock returns and that is O.K. We
know there is a wide range of “normal” stock
returns based on historical results. Rather than
assuming an average expected return, think in
terms of ranges and how actual returns near
the bottom of those ranges could impact your
financial plan.
Second, work to reduce the range of likely
returns by including high quality bonds in
your portfolio. One of the strongest arguments
for diversifying stock portfolios with high
quality bonds is that they reduce the range
of investment outcomes to something more
manageable for investors.
Fifth Set Investment Advisors LLC is a registered in-
vestment adviser. Information presented is for edu-
cational purposes only and does not intend to make
an offer or solicitation for the sale or purchase of
any specific securities product, service, or invest-
ment strategy. Investments involve risk and unless
otherwise stated, are not guaranteed. Be sure to
first consult with a qualified financial adviser, tax
professional, or attorney before implementing any
strategy or recommendation discussed herein.
Larchmont resident Ian A. Post, CFA is the Principal of Fifth Set Investment Advisors LLC. Fifth Set is the result of his evolution of thought in regard
to conventional investment management. His experience and education led to research for a smarter approach to portfolio management and
financial planning. Prior to Fifth Set, Ian conducted fundamental equity research at Citigroup, Credit Lyonnais and CIBC Oppenheimer. Ian earned
a BS in Engineering and Public Policy from Washington University and an MBA with concentrations in Finance and Statistics from NYU and is a
holder of the Charted Financial Analyst designation and a member of CFA Institute.
1
A quote from the publisher’s description of The Signal and the Noise by Nate Silver. 2 The fivethirtyeight model gave Trump a roughly one in three chance of winning heading into the election. 3The
model’s basic premise was that with a Clinton national poll lead of about 3% to 4%, a polling error against Clinton equal to the one from 2012 (Mitt Romney underperformed national polls by about
3%), would be enough to cause Clinton’s wide, but not deep by individual state, Electoral College lead to slip away leading to a Trump victory. 4
From 1/1926 through 12/2015, the average annual
return on the S&P 500 was 11.95%. 5
1965 (12.5%), 1959 (12.0%) and 1926 (11.6%).6
For a Normal Distribution, approximately 68% of outcomes occur within one standard deviation of the mean.
7
Extreme stocks returns occur more frequently than would be expected if returns were normally distributed.

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Appreciating Uncertainty: Elections, Investing and Setting Expectations for the Future

  • 1. 8 Helping Larchmont Families Plan for the Future Ian A. Post, CFA Fifth Set Investment Advisors LLC • 2065 Boston Post Road • Suite 200 • Larchmont, NY 10538 Email: ipost@fifthsetinvestment.com • Web: www.fifthsetinvestment.com • Phone: 646-783-9717 • Portfolio Management • Financial Planning • Investment Insights Investment Corner IanA.Post,CFA “The Prediction Paradox: the more humility we have about our ability to make predictions, the more successful we can be in planning for the future.”1 The results of the presidential election made some people happy and some sad but most everyone was surprised. I personally was ob- sessed over the last few months with election polls, models and predictions. One of the models I followed closely was fivethirtyeight.com, a website developed by Nate Silver, a statistician who specializes in forecasting sporting events and elections. While he didn’t outright predict a Trump win, he made a strong case that Trump could2 win. What Silver and his model successfully incor- porated was an appreciation of uncertainty3 . So, what can we learn from pre-election polls that seemed to assure a Clinton victory that can help us manage our investments? Most people are familiar with the historical average return on stocks of about 12%4 . But what is the likelihood of a 12% return in any particular year? How shocking would it be if stocks lost 20% or more? Let’s look at some history. We have a total of ninety calendar year returns for the S&P 500 beginning in 1926. Out of those, how many would have met expectations assuming we always expect a 12% return? A grand total of three5 ! In only three calendar years, or roughly 3% of the time, did equity returns match the 12% expectation. How often have we had losses of 20% or more? That also has been a fairly rare event with only six calendar year returns of 20% or greater losses. How about losses of any size? The S&P 500 has delivered negative returns 24 times since 1926 or slightly more than 25% of the time. Thinking about future stock returns as a range of possible outcomes can help us appreciate investment uncertainty. Assume we knew for certain that the mean expected return for stocks was 12%; we would still be faced with a very wide range of possible “normal” returns. Since 1926, the standard deviation6 of S&P 500 returns is 20%. Using that information, we can say that about two-thirds of the time, we should expect a return in the range of plus or minus 20% from the mean or -8% to 32%. The range covering 95% of annual returns is -28% to 52% and for 99% of annual returns, the range is -48% to 72%. Amazingly, even these ranges underestimate the true uncertainty because 1) we don’t know the expected mean return going forward and 2) stock returns are not normally distributed7 . So, what to do with all this uncertainty? First, take a step back and accept that we simply can’t make accurate single number predic- tions about stock returns and that is O.K. We know there is a wide range of “normal” stock returns based on historical results. Rather than assuming an average expected return, think in terms of ranges and how actual returns near the bottom of those ranges could impact your financial plan. Second, work to reduce the range of likely returns by including high quality bonds in your portfolio. One of the strongest arguments for diversifying stock portfolios with high quality bonds is that they reduce the range of investment outcomes to something more manageable for investors. Fifth Set Investment Advisors LLC is a registered in- vestment adviser. Information presented is for edu- cational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities product, service, or invest- ment strategy. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser, tax professional, or attorney before implementing any strategy or recommendation discussed herein. Larchmont resident Ian A. Post, CFA is the Principal of Fifth Set Investment Advisors LLC. Fifth Set is the result of his evolution of thought in regard to conventional investment management. His experience and education led to research for a smarter approach to portfolio management and financial planning. Prior to Fifth Set, Ian conducted fundamental equity research at Citigroup, Credit Lyonnais and CIBC Oppenheimer. Ian earned a BS in Engineering and Public Policy from Washington University and an MBA with concentrations in Finance and Statistics from NYU and is a holder of the Charted Financial Analyst designation and a member of CFA Institute. 1 A quote from the publisher’s description of The Signal and the Noise by Nate Silver. 2 The fivethirtyeight model gave Trump a roughly one in three chance of winning heading into the election. 3The model’s basic premise was that with a Clinton national poll lead of about 3% to 4%, a polling error against Clinton equal to the one from 2012 (Mitt Romney underperformed national polls by about 3%), would be enough to cause Clinton’s wide, but not deep by individual state, Electoral College lead to slip away leading to a Trump victory. 4 From 1/1926 through 12/2015, the average annual return on the S&P 500 was 11.95%. 5 1965 (12.5%), 1959 (12.0%) and 1926 (11.6%).6 For a Normal Distribution, approximately 68% of outcomes occur within one standard deviation of the mean. 7 Extreme stocks returns occur more frequently than would be expected if returns were normally distributed.