Some Thoughts on Static vs Dynamic Projections

We all have to make projections about the future in just about everything that we do.  It’s just a fact of life.  When one invests their money in certain instruments the ability of those instruments to meet your financial goals will depend on a certain degree of projection about the future and the way those instruments will perform.  Some of us look at historical data and project it forward while others take a more forward looking perspective and engage in what could be thought of as guesswork (or, at times, rejecting the idea that past is prologue).  Forecasting the future is part of any honest approach to asset allocation.

What’s interesting about projecting the future is not necessarily whether you’re trying to project the future or not, but how dynamic your model is in achieving this.  This gets very tricky for several reasons.  Someone like Jeremy Siegel, who’s become famous for his “Stocks for the Long Run” perspective, has a very static view of the world.  That is, he basically assumes that economic growth will continue into the future and that means stocks will expand over time and if you have a long enough time horizon then you are best off owning a portfolio of equities (he’s even recommended leveraging that portfolio up if you can stomach it).  This is a perspective that is generally based on fine assumptions (eg, betting on long-term economic growth is a pretty smart bet in general).  But it also doesn’t reflect our financial lives all that realistically because our financial lives are quite dynamic.  Our financial lives are not these static sort of linear experiences.

This reality is why people love Robert Shiller so much.  Shiller’s view is more dynamic.  Shiller basically says that the world is super duper complex, extremely dynamic and that the market’s participants are extremely irrational.  Shiller uses quite a bit of historical data in his work, but he’ll be the first person to tell you that the past is not necessarily prologue.  People relate to this view because they can see how dynamic their lives are.  Shiller’s model based on irrational behavior and dynamism is something that resonates with people because we experience it every day whereas Siegel’s long-term view is something that doesn’t resonate on a daily, monthly or even an annual basis.

So, which type of view is actually more helpful?  It depends quite a bit.  In a general sense, Siegel’s view is right because the world does tend to adhere to the big trends that drive Seigel’s thinking.  But in a more micro sense Shiller is right and the world does go through these periods of turbulence in the near-term that are consistent with a dynamic world view.

Now, is one model necessarily better than the other?  No!  There are parts of the Seigel and Shiller model that are both right.  And there are parts of both models that are wrong.  Finding which one applies to you more appropriately is a process of learning how certain ideas apply to your personal needs.  There’s a lot of dogma in the world about certain views being “right” or “wrong” when the truth usually lies in the middle.