Many investors believe that financial markets exist to facilitate the efficient allocation of capital. That’s a myth. The purpose of financial markets is to humiliate anyone who thinks he can predict how they will perform in the short run. And those who are most certain that they know how the markets will perform will generally get the biggest surprise.
The consensus emerging on Wall Street is that U.S. stocks will have a decent year in 2014, perhaps returning 8% or 10%. That sounds plausible; since 1926, when modern data on the U.S. stock market began, stocks have averaged a gain of 10.1% annually. But in how many of those years did stocks return between 8% and 10%? In 88 years, it has never happened once. Stocks almost always perform either much better, or much worse, than investors expect them to. That’s why relying on the comfort of a consensus forecast is so dangerous. As G.K. Chesterton wrote, “Wisdom should reckon on the unforeseen.” So should investors.
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This article was originally published on The Wall Street Journal.