Luck is an often an unappreciated concept.

Merriam-Webster defines luck as “a purposeless, unpredictable, and uncontrollable force that shapes events favorably or unfavorably for an individual, group, or cause” and “a chance combination of circumstances or conditions operating for or against the individual.” Both definitions apply to investing.

The outcome of our portfolios, including whether or not we have enough wealth to achieve our lifetime goals (which may or may not include passing along assets to heirs or other designated beneficiaries), depends in part on luck. Yes, the decisions made—including securities and funds purchased, the allocations chosen and the strategy(ies) followed—significantly impact investing success, but they are just part of the equation. The other part is the cumulative return of the securities or funds that are invested in and the sequence in which those returns occurred.

Princeton professor Burton Malkiel describes stock prices as following a random walk. Though some like to argue with his assessment about the unpredictability of short-term market movements, over longer periods of time it’s impossible to correctly predict how stock prices—or those of any other asset class—will change. Even if someone were to get close in terms predicting the actual level that the S&P 500 index will be at in 10 or 20 years, it’s improbable that they would get the sequence of returns that led to the eventual price point correct. There are simply too many scenarios, both foreseeable and unforeseeable. (Even many of the foreseeable scenarios are only truly predictable with the benefit of hindsight.)

Contrast this with the human preference for certainty. When a forecast is given by a person exuding confidence, our psychological tendency is to give it more credibility. Even if there is absolutely no assurance of the forecast ever becoming true, we’ll be inclined to believe it if the forecast is given in an assured manner.

In the field of investing, this can be problematic. Numerous studies have shown that analysts’ forecasts are commonly wrong. In an average quarter, 63% of S&P 500 companies beat earnings estimates, according to Thomson Reuters I/B/E/S. Add in the number of companies that disappoint and analysts are wrong more than two-thirds of the time during an average quarter. Extend their forecasts out to longer periods and the accuracy gets even worse. If the professionals who are paid to know a specific company inside and out have problems getting their forecasts correct, think about how difficult it is to make predictions for where the S&P 500 is going to trade at one year, five years, 10 years or even 20 years from now.

Again, it’s not just the forecast that matters, but how prices get there. The sequence in which returns occur will impact your wealth. Plus, any changes you make during your investment time horizon will further alter the result. For example, taking withdrawals from stocks when a bear market is occurring can compound the damage being done to your portfolio. In this month’s issue, I explain here the sequence of returns concept further and give some steps that can be taken to mitigate the damage caused by a series of negative returns, particularly those occurring at the most inopportune time.

Also in this issue are articles from three speakers at our forthcoming Investor Conference. John Buckingham discusses the value of dividends, Jordan Kimmel explains how many stocks are necessary to be diversified and Wesley Gray gives suggestions for improving the Piotroski High F-Score strategy. If you enjoy their articles, come to Las Vegas this November and see them. Information about the conference is at www.aaii.com/conference. I hope to see you there.

Wishing you prosperity,

Charles Rotblut, CFA
Editor, AAII Journal
@CharlesRAAII