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Billy Burrows: The perils of trying to forecast the future

If the best and brighest struggle to predict future events, why should annuity buyers be any more accurate?

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I am writing this column from the PFS conference in Birmingham. It is good to be surrounded by advisers and product providers who are clearly committed to improving the financial well-being of the country.

The keynote speaker was the well-known Financial Times columnist and presenter of Radio 4’s “More or Less”, Tim Harford. His presentation looked at financial forecasting and how nobody can accurately forecast future events. He provided some graphic examples of how some very clever people and powerful companies made a complete hash of forecasting future financial trends. The most graphic example was from Goldman Sachs.

At the beginning of the 2007 financial crisis, the chief financial officer of Goldman Sachs explained that shares were moving in ways that were the opposite of those predicted by computer models and they were seeing “25 standard deviation moves, several days in a row”.

Translating this into English, Tim said this means according to the models used they were “very unlucky”. Or put it another way this sort of bad luck would only happen every 28, 900, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000, 000 years, given certain assumptions about what Goldman might have meant.

To put this in context, the universe is about 14,000,000,000 years old. Tim went on to say the alternative to the “very unlucky” hypothesis, is that the quantitative models did not produce very good forecasts.

This may a very dramatic way of explaining that many of the current models for predicting the future may not be very good but it does serve as a wake call when we think about may happen over the longer term.

My latest obsession is with getting advisers and their clients to take a longer view of retirement income requirements and I am like a record when I say pensioners face a number of future unknowns; they don’t know how they long they will live, what will happen to inflation, equity prices and interest rates and they do not know what may happen to their health.

In short, investing in a level annuity may seem like a no risk strategy but individuals are still at risk from the effects of inflation and so on.

As I was struggling to make a link between the 25 standard deviation story and annuities I met my friends from Prudential who had my paper ‘Annuities at a Tipping Point” on their stand, my old friend Ian Naismith from Scottish Widows who was off to talk about retirement income options and the well-known Mike Morrison. All have made the important point that those who have larger enough pension funds should consider investing a range of annuity and drawdown policies.

Hopefully we will not be so unlucky in our future predictions as the example above but one way to reduce risk is to remember the old adage ‘don’t put all of your eggs in one basket’. 

Billy Burrows is director of the Retirement Academy

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