A Brief Reminder of How Fast Things Change

If there's one lesson of the past decade, it's that things change -- fast.

A good example: Read what President Bill Clinton had to say in the 2000 State of the Union address:  

We are fortunate to be alive at this moment in history. Never before has our nation enjoyed, at once, so much prosperity and social progress with so little internal crisis and so few external threats. Never before have we had such a blessed opportunity -- and, therefore, such a profound obligation -- to build the more perfect union of our founders' dreams.

We begin the new century with over 20 million new jobs; the fastest economic growth in more than 30 years; the lowest unemployment rates in 30 years; the lowest poverty rates in 20 years; the lowest African-American and Hispanic unemployment rates on record; the first back-to-back budget surpluses in 42 years. And next month, America will achieve the longest period of economic growth in our entire history.

We have built a new economy. And our economic revolution has been matched by a revival of the American spirit: crime down by 20%, to its lowest level in 25 years; teen births down seven years in a row; adoptions up by 30%; welfare rolls cut in half to their lowest levels in 30 years.

My fellow Americans, the state of our union is the strongest it has ever been.

And then compare it to President Barack Obama's remarks during the 2010 State of the Union:

One year ago, I took office amid two wars, an economy rocked by a severe recession, a financial system on the verge of collapse, and a government deeply in debt. Experts from across the political spectrum warned that if we did not act, we might face a second depression. ... One in 10 Americans still cannot find work. Many businesses have shuttered. Home values have declined. Small towns and rural communities have been hit especially hard. And for those who'd already known poverty, life has become that much harder. This recession has also compounded the burdens that America's families have been dealing with for decades -- the burden of working harder and longer for less; of being unable to save enough to retire or help kids with college.

It took just 10 years to go from Brady Bunch to Mad Max. I think that's incredible.

And this lurch in prosperity wasn't a one-off event. As Clinton noted in the 2000 speech, "Eight years ago, it was not so clear to most Americans there would be much to celebrate in the year 2000. Then our nation was gripped by economic distress, social decline, political gridlock. The title of a best-selling book asked: 'America: What Went Wrong?'"

In 1992, things looked awful. In 2000, all we could see was optimism. In 2010, we were staring straight into the abyss. Former Treasury Secretary Larry Summers has a saying: "A good rule of thumb for many things in life holds that things take longer to happen than you think they will, and then happen faster than you thought they could." That seems fitting these days.

What's amazing about the differences among 1992, 2000, and 2010 aren't the forces that caused the shifts -- a technology boom and a housing bust. It's how fast the shifts took place, and how few saw them coming.  

When dealing with anything that requires us to anticipate the future, one of the most troubling things to come to terms with is how poorly hardwired we are to make accurate predictions. As a 2005 Deutsche Bank report noted, "Who could have imagined in 1991 that a decade of stagnation would beset Japan? Who would have forecast in the same year that an impressive rebound of the U.S. economy was to follow? Simply extrapolating the past cannot provide reliable forecasts."

Yet it's what most of us do. In 2005, the investment bank Dresdner Kleinwort wrote a paper on the history of financial forecasts, and found a startling pattern. When a composite of expert forecasts on things like bond yields and stock prices were overlaid with what actually happened, the forecasts had an almost perfect lag. A few months after bond yields rose, analysts broadly forecast that they would keep rising. A few months after yields fell, analysts switched their forecasts and predicted that yields would continue to fall. Viewed in a chart, it was unmistakable: When forecasting the future, analysts were simply looking at what happened in the past and drawing a straight line. "Analysts are terribly good at telling us what has just happened but of little use in telling us what is going to happen in the future," the report wrote.

So what should you do about it? How do you deal with the unpleasant fact that most of us -- including me, and likely including you -- are terrible at predicting the future? I think there are three things to keep in mind.

1. Think long and hard about the risks you're taking
In 1998, a group of "genius" financiers at a hedge fund called Long Term Capital Management, stacked with Ph.D.s and Nobel laureates, lost nearly every penny they had. At one time, these managers had extraordinary personal fortunes. By taking even more extraordinary risks, they went flat broke.

Warren Buffett later made a wonderful comment about the ordeal:

To make money they didn't have and didn't need, they risked what they did have and did need. And that's foolish. It is just plain foolish. If you risk something that is important to you for something that is unimportant to you, it just does not make any sense.

Average folks do this, too, and a lot has to do with being overconfident that the future will look like the past. I knew a guy who already had a good retirement nest egg built up. He could have lived comfortably off it, yet he blew most of it in a feverish attempt to make more by buying up "investment" homes in Orange County, Calif., in 2005. He's now back at work.

When we think about our investments, there's often too much emphasis on potential gains and not enough on potential losses. In his book The Behavior Gap, financial advisor Carl Richards lays out three questions you should ask yourself before making a big financial decision:

  • If I make this change and I am right, what impact will it have on my life?
  • What impact will it have if I'm wrong?
  • Have I been wrong before?

Most of us could do better by asking ourselves these questions. It's a smart way to think about risk. And as Richards writes, "Risk is what's left over when you think you've thought of everything else. Our assumptions about the future are almost always wrong. We can never think of everything -- but we can take sensible steps to protect ourselves from life's inevitable surprises."

2. Whatever you're feeling, stop and think the opposite
It's impossible to predict the future, but you can do worse than following a simple rule: Whenever the economy is doing extremely well or extremely poor, there's a good chance that things will soon turn in the opposite direction. After booms come busts, and after busts come booms.

After the Roaring '20s came the Great Depression. Then came the booming 1950s and 1960s. After the miserable 1970s came the thriving 1980s and 1990s. Next came the hellacious 2000s. Boom, bust. One after another.

It always works this way. Recessions plant the seeds of recoveries, and booms plant the seeds of recessions. It's counterintuitive, but the absolute best time in modern history to invest was in the midst of the Great Depression in 1933, and the absolute worst time was in 2000, when the future never looked so bright. How many investors foresaw these outcomes at the time? Almost none.

Assuming a State of the Union address is reflective of the mood of the economy, those who think the future is more important than the past should want more speeches like Obama gave in 2010, and should fear those like Clinton gave in 2000.

3. Stop trying to predict what's next
According to Standard & Poor's, two-thirds of actively managed stock funds have underperformed the S&P 500 over the last three years. About the same portion have failed over 10-, 15-, and 20-year periods. According to author Simon Lack, if all the money ever invested in hedge funds had instead been invested in Treasury bonds, the results would have been twice as good.

Think about that. How many man hours have fund managers put into researching, calculating, and prognosticating the future, all for nothing? How many brilliant MIT grads worked until 3 a.m. building forecasting models that turned out to be totally wrong? What if these people had instead just gone to the beach? Or worked at something more productive?

The best way to deal with uncertainty about the future is to accept it. You don't know what's going to happen next. So what? You don't need to. Set yourself up so that you'll do OK regardless of what happens. Save your money. Diversify. Avoid debt. Be ready to adapt. Know that anything can happen at any time.

This is boring, but it offers the best chance at beating the masses who have fooled themselves into believing they're smarter than they really are -- those who haven't learned that things change, fast. As Lao Tzu put it, "Those who have knowledge don't predict. Those who predict don't have knowledge." Smart advice.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (30) | Recommend This Article (96)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 31, 2012, at 6:11 PM, donws11 wrote:

    Insightful comments.

  • Report this Comment On January 31, 2012, at 6:34 PM, Darwood11 wrote:

    Great article!

    Yes, it is easy to forget how quickly things change. That is one of the reasons I find Bernanke's comments, as quoted elsewhere, that inflation "will remain low through 2014" to be somewhat disturbing. Really?

    Wow! A lot can happen in 2-3 years.

    Remember the rosy projections of 2007 and the housing market? Of course we do!

    I'm not going to quote Lao Tzu, but I do suggest "Hold on to your hats!" That, by the way, doesn't mean I'm suggesting things will get worse.

  • Report this Comment On January 31, 2012, at 6:54 PM, portefeuille wrote:
  • Report this Comment On January 31, 2012, at 9:12 PM, portefeuille wrote:

    brilliant MIT grads worked until 3 a.m. building forecasting models

    ----

    it is a little past 3 a.m. over here. my fund here -> http://caps.fool.com/Blogs/fund-trades/698299.

  • Report this Comment On January 31, 2012, at 9:55 PM, seattle1115 wrote:

    In 2000, no one could have predicted that someone would come along and start two wars (one of which was completely pointless) while at the same time slashing revenues. While your point is a good one, the example you chose to illustrate it is less than ideal - not all economic U-turns are unpredictable.

  • Report this Comment On January 31, 2012, at 11:07 PM, davidm9999 wrote:

    Bill Clinton was obviously oblivious to the goings-ons around him. A huge social security obligation that was about to come due, a world that was boiling with hatred and jealousy, and of course, a new generation of adults about to enter a workforce that had no place to put them. He was tooting his own horn. Him, and all the adult teenagers that he worked with were perfectly happy to ignore the oncoming train so that they could sing and be merry in the exact moment they were in. Good people plan for the future, so they can enjoy it when it comes, not so that they can live it up in the moment and cross their fingers about the future. America was no way in the clear in 2000. Not at all

  • Report this Comment On January 31, 2012, at 11:47 PM, HistoricalPEGuy wrote:

    Holy smokes, what a great article. Morgan - check out Leonard Mlodinow's view on randomness - very tightly aligned with your point of view.

    I am a huge fan of yours after reading this!

    - HPEGuy

  • Report this Comment On February 01, 2012, at 8:53 AM, ravenesque wrote:

    4. Strike while the iron is hot (so to speak).

    http://michaelfury.wordpress.com/2011/11/11/pulverized-to-ne...

  • Report this Comment On February 01, 2012, at 10:41 AM, matola44 wrote:

    For me, those who set the stage his philosophers, and those who are making a difference in the screw are technogrates. the United States its a good ground (almost the first in the world) for philosophical research. including religious. together they are the first power of technology. without good philosophers in a country not well technology. So you need people to prepare terreain cutter on the other's life when everything decided by the materialization.

    www.monana.net

  • Report this Comment On February 01, 2012, at 10:45 AM, matola44 wrote:

    ry, I meant, "and those who change things in life are technogrates"

  • Report this Comment On February 01, 2012, at 12:31 PM, Dyengii wrote:

    @porte

    Not sure what you are getting at, exactly. Try adding the US to your GDP graph, for instance.

  • Report this Comment On February 01, 2012, at 1:28 PM, Foosballking wrote:

    "so few external threats..." Right. Meanwhile his crack staff - Jamie Gorelick to be specific (and among many others) was setting us up for intelligence failures resulting in 9-11. Clinton was, and is, a self-centered leftist boob (remember Hillary-care? Clinton wanted socialism as much as any other democrat). And now we have an extreme leftist, probably worse than any before who is hell bent on destroying us. Not a good way to open the article.

  • Report this Comment On February 01, 2012, at 1:47 PM, Hawmps wrote:

    Great article Morgan.

    And the investing moral of the story... When everything is rainbows and unicorns, time to sell. When there's blood in the streets, time to buy it back.

  • Report this Comment On February 01, 2012, at 2:53 PM, DJDynamicNC wrote:

    @Foosball: Political leanings aside for the moment, your comment is factually wrong.

    To wit: "January 25, 2001 Richard Clarke Memo: "We urgently need . . . a Principals level review on the al Qida network."

    Clinton specifically warned Bush about Al Quaida, Clinton specifically went after Bin Ladin, the security apparatus that Clinton left in place specifically noted that Bin Ladin would attempt to strike at the US using airplanes, even producing a memo for Secretary Rice entitled "Bin Ladin determined to attack the United States" early in Bush's term. All of which was ignored. That is simple fact. I don't blame Bush for the mistake all that much - the President has a lot to deal with, 9/11 was unprecedented, and Bush was, uh, in a liitle over his head, so to speak - but I certainly don't see how you can rationally blame Clinton. That's like the people who blame Obama for the housing crash and TARP bailout that occurred before he was even elected. Which, judging from the tone of your comment, you might also do.

    Morgan studiously avoided pointing it out, but 1992 when everything was falling apart was after 12 years of Republicans. 2000, when everything was turned around and stronger than ever, was after 8 years of Democrats. 2008, when everything was falling apart, was after 8 years of Republicans.

    I'm going to get all sorts of pushback on this from our resident right-wingers (and well I should - they should defend their views just as I defend mine), and certainly the picture is made up of more factors than just those, but the correlation is worth noting.

  • Report this Comment On February 01, 2012, at 4:13 PM, drborst wrote:

    @DJDynamicNC

    I largely agree with you.

    But where you were expecting pushback, I'd point out that Clinton didn't have a democratic majority in congress for most of those eight years. Nor did Reagan during the good parts of his 8. That's enough of my lifetime to have made me think the best governement was a divided one.

    Sadly, I think past year has proven me wrong.

    Morgan, I like the article, except this line

    <<It took just 10 years to go from Brady Bunch to Mad Max. I think that's incredible.>> I suspect you don't find that incredible at all. You've been writing for a long time about uncertiantity and market cycles and financial panics. I think you mean to say most financial "experts" find that incredible, but surely not you. Say it ain't so.

    DRB

  • Report this Comment On February 01, 2012, at 4:17 PM, Jellywig wrote:

    Enjoyed the article Morgan. You sound a little like the scientist/investor Nassim Taleb. If you haven't read his book The BlacK Swan you may want to check it out. While I don't agree with all of his economic philosophy (he's primarily invested in Hedge funds I believe), he makes some strong points on expecting the unexpected to say the least i.e Tsunamis, the interconnectdeness of the global financial system (housing bubble) etc.

  • Report this Comment On February 01, 2012, at 6:19 PM, Sunny7039 wrote:

    Wow, this is great.

    Housel, suddenly you're smokin'.

    Re: Nassim Taleb -- it's really worthwhile to read Fooled By Randomness first, and to see what his buddies (like Kahneman and Roubini) have to say.

    To the best of my knowledge, Taleb has said that he puts the vast majority of his funds in Treasuries, and then takes a few extreme risks now and then, because by having many years of living expenses in T bonds, he is a hard target and can afford to take an outsized risk when the occasion presents itself. He most decidedly does not put a large chunk of his financial assets in hedge funds. At least, this is what he says. Him, I tend to believe.

  • Report this Comment On February 01, 2012, at 6:47 PM, MartyTheCanuck wrote:

    DJDynamicMC

    Another way to look at it is the policies of the '80 set us up for the thriving '90, the policies enacted in the '90 gave us the lost decade of 2000-2010.

    Maybe both your simplified view of Republican=evil and Democrats=good is wrong, and my childish simplification above is also wrong.

    I believe the recession was caused bu the housing bust, the bust following decades of pro-housing policies ( 60% Dem-40%Rep in my view ), too low interest rates ( thank you Mr Greenspan ), and a financial system that rewarded firms that were writing mortgages and selling to the next one in line, including GSEs. Plus people with unreasonable expectations that were buying houses they couldn't afford. The Iraq after-war wasn't well planned, but it doesn't have much to do with the current crisis, except for increasing the debt. But if you want to talk about debt, how about the last 3 years...

    Thanks Morgan for a good column, I can wait to read your e-book now.

  • Report this Comment On February 01, 2012, at 7:41 PM, Sunny7039 wrote:

    Yes, the policies of the '80s most certainly did set us up for the "thriving" '90s -- they set the stage for bubble-omics.

    Real wages have been very close to stagnant since 1980. The '90s saw the first massive shift of wealth from producers to FIRE, but not too many people were complaining because quite a few did share in the faux wealth, and most of the rest still believed they "could have" shared, had they only been a little smarter, or quicker. The next phase threw some cold water on that idea. And the next time it happens (and it's coming), it will be worse still.

    If I'm being too obscure, here's what I think: The "prosperity" of the '90s was mostly a bubble. Worse yet, it changed the way people look at things. It's better to manipulate than to produce, it's better to grab quick money than to build a business, much less a real industry, it's better to have more no matter how you got it -- it's all good, as long as you don't end up in court, or in jail.

    To think any other way is to be a loser. Everyone who's anyone thinks this way. It's human nature. Those who decry it are jealous. They'd love a piece of this action, but are too lame to figure out how to get in on it.

    You know it's true. And it is all traceable to key decisions made during the Reagan administration, and to the ideological climate Reagan and Thatcher created.

    But the really funny part is that some people still call this "conservative."

    And no, I don't think either party is "better." I see no good guys at the top in this sorry picture.

  • Report this Comment On February 02, 2012, at 6:38 AM, MartyTheCanuck wrote:

    Sunny, sure a lot of people are trying to make money, and there is more opportunities in a boom than in a bust. The bubbles are often inflated assets, on top of debts, and we have a ton of that since the late '90. But there was still an increase in productivity and in standards of living that was true.

    And can you name the key decisions of Reagan and Thatcher that led to those bubbles ?

  • Report this Comment On February 02, 2012, at 11:30 AM, hbofbyu wrote:

    Some good points that were found in your book - which does not suck.

  • Report this Comment On February 02, 2012, at 11:32 AM, TMFHousel wrote:

    <<which does not suck.>>

    Best review yet! Thanks!

  • Report this Comment On February 02, 2012, at 11:35 AM, DJDynamicNC wrote:

    @Marty - that's a reasonable counter claim. Following your logic, then, it would stand to reason that the Republican policies enacted in the 2000s would have set us up for the oustanding economic boom we're currently experiencing in the following decade, isn't that right?

    I will freely admit to filtering my understanding through my own preconceptions - all human beings do this, and you are as well, and that's fair. But being partisan and being right are not mutually exclusive.

    And if you want to talk about debt, let's talk about it in the totality of all that it represents. Debt is not inherently bad. If I have a business opportunity with the potential to invest in my business and stimulate decades of growth and development with money that's available at extremely low rates, then I'd be a fool to pass that up. Similarly, if the United States government can borrow money at rates so low that they are effectively negative, and use that money to put people to work and generate direct economic activity, enhance the velocity of money in the economy, aid in private deleveraging, and make essential investments in national infrastructure and the regulatory environment, well that's simply smart business practice. At least as importantly, it is also a massive quality of life improvement for millions of people who would otherwise be suffering due to the economic picture. That matters.

    Institutions and money exist to serve people. Not the other way around.

  • Report this Comment On February 02, 2012, at 6:40 PM, MartyTheCanuck wrote:

    DJ

    I don't think that the Reps did a good job in the last decade, they made a mess, but the the Dems have been in control of Congress since 2006 and did nothing to prevent the housing meltdown. They were willing to "roll the dice" as they said. Well thank to Reps and Dems, they roll the dice and we lose.

    Regarding debt, I agree that "all debt isn't bad". Only debt that you can't repay or that bring you down is bad. We'll see when we get there. But Bush got us closer, and Obama too, like it or not.

    Do you feel that Greece debt is "simply smart business practice" ?

    "Institutions and money exist to serve people. Not the other way around." Agree 100%. But people include our children and granchildren, who shouldn't have to pay for our spending binge eh... sorry, "investments in our future".

  • Report this Comment On February 03, 2012, at 8:38 AM, rdwicker wrote:

    BAM!

    Nice Work, AGAIN, MoHouse!

  • Report this Comment On February 03, 2012, at 11:34 AM, WileyCyote wrote:

    Very good piece. A lot to think about.

    Canit happen again. YES IT CAN! Have you seen anyone going to jail for anything? If this wonderful government is so concerned where is Glass-Steagal? The banks that were "too big to fail" are now too big to fail once again. The SEC continues to give the big banks one pass after another while "enforcing" the rules on smaller organizations. The news media continues to use the word "misakes" where the terms that should be used are "treachery" and "deceipt"

  • Report this Comment On February 03, 2012, at 2:05 PM, DJDynamicNC wrote:

    @Marty: You're right that the Dems bear some of the blame as well. They did nothing to prevent the housing disaster. But please bear in mind that by making this argument you're accepting the core of my own - that government should indeed have been acting to address the housing bubble by doing things like reinstating Glass-Steagall and ensuring adequate funding for regulatory agencies, including sufficient top-level pay to prevent regulatory capture. This is very much a government role, and it is ONLY the Democrats that advocate for meeting these obligations. THat's why despite their (many) failures I remain committed. I'd rather shoot for the right target and miss 60% of the time than be aiming in completely the wrong direction.

    As for debt - agreed, if there was debt we couldn't repay, that would be a problem. But it is physically impossible for us to run out of dollars. We are not bound, like Greece, to a currency outside of our control. And the market responds to these factors, which is why bonds continue to sell at incredibly low (and in some cases effectively negative) interest rates. We've been in much deeper before, and we grew our way out of it sufficient taxation rates on the top end, reasonable military spending (we are spending more now on "defense" than we did during the Cold War) and yes, responsible spending structures.

    Additionally, the voluntary compliance rate on IRS tax collection in the United States is drastically higher than in Greece; that's an important consideration when making that comparison.

    And if you want to talk about not making our children pay, then I would argue that that incldues not cutting off their education, destroying their social safety net, punishing them for the mistakes their parents have made, leaving them with a collapsed job market, or denying them healthcare. The alternative to that is what - push debt up temporarily (financed with bonds issued at historically low interest rates) and maybe experience some additional inflation? It would be inhumane in the extreme not to make that bargain.

  • Report this Comment On February 05, 2012, at 7:58 PM, ghenry232 wrote:

    Just thought I'd say that with what you say about the 2000/2010 speeches, this image is quite apt:

    http://i.imgur.com/Oqza3.jpg

  • Report this Comment On February 07, 2012, at 7:49 AM, RetiredinFL08 wrote:

    Great piece reflecting on the reality of the economy and its importance on successful investing. I would love to see more of this insightful quality permeate what I read, especially in the Fool. Can I share it? Thank you

    Tom

  • Report this Comment On February 19, 2012, at 1:36 PM, thidmark wrote:

    "1992 when everything was falling apart was after 12 years of Republicans. 2000, when everything was turned around and stronger than ever, was after 8 years of Democrats. 2008, when everything was falling apart, was after 8 years of Republicans."

    This is just silly. You refuted a dopey partisan statement, with an equally dopey one.

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