It’s Better to be Partly Right than Mostly Wrong

I’ve always adhered to the perspective that it’s better to be partly right than mostly wrong. I think this is a pretty good way to describe how we should think about our portfolios and forecasts of the future. No one is going to be right all the time. But if you get the directionality of big trends right you’re very likely to do better than most other people.

For instance, if you fell into the hyperbolic inflationist camp back when QE was starting then you got the directionality of almost everything wrong. You likely predicted rising interest rates, soaring commodity prices, falling USD denominated equity prices and a collapse in the USD exchange rate.  If, on the other hand, you understood that QE wasn’t very likely to cause high inflation then you probably didn’t get scared out of bonds or stocks, but looked at commodity prices with some skepticism.  That was essentially my view over the last 5 years. Getting the directionality of a big trend wrong is far worse than getting that trend partly right.

This sort of thinking is also the cornerstone of diversification. People who don’t want to try to time the market or forecast future returns basically make one big implicit forecast – they assume growth will be higher in 10-20 years than it is today. This attaches a portfolio of diversified stocks and bonds to an income stream that is probably expanding with time. They don’t have to be 100% right. In fact, they’re owning the bonds precisely to dampen the negative potential impact of stocks at times. But the thinking is the same – it’s better to be partly right than mostly wrong.  This is why living on the extremes is so dangerous for investors. It exposes them to the potential that they’ll be all wrong.

That said, I really loved this line from Ben Bernanke in a piece this morning:

It’s generous of the WSJ writers to note, as they do, that “economic forecasting isn’t easy.” They should know, since the Journal has been forecasting a breakout in inflation and a collapse in the dollar at least since 2006, when the FOMC decided not to raise the federal funds rate above 5-1/4 percent.

We see this all the time on Wall Street. Pundits like to bad mouth economic forecasters and market forecasters for missing precise figures about directionality. I always laugh when I read an article on some fear mongering website about how Wall Street’s analysts set price targets that didn’t end up being exactly right even though they got the directionality right and the critic got it dead wrong. This is very unfair and what Ben Bernanke is basically saying is that they at least got the directionality right.  It’s better to be a raging bull in a disappointing bull market than it is to be a raging bear in a disappointing bull market.  Directionality matters a lot more than precision. In fact, smart investors know that they don’t have to be precise. They just have to be more right than wrong.