DIY Financial Advisor. Vogel Jack R.

phase. A key principle of this three-step decision-making process is that discretionary experts are required to develop and assess, but execution is made systematic, so as to minimize human error. The Marines, like other critical decision makers, want experts to develop and assess SOPs in a stable training environment. However, the Marines want to implement SOPs systematically when the environment shifts from the training environment to the live battlefield.

The Expert's Hypothesis

      The so-called expert's hypothesis, which asserts that experts can outperform models, is intuitive and tells a deceptively compelling story. For example, to most, it seems like common sense that a hedge fund manager with a Harvard MBA and 20 years of work experience at Goldman Sachs can beat a simple model that buys a basket of low P/E stocks. The logic behind this presumption is persuasive, as the expert would seem to possess a number of advantages over the model. The expert can arguably outperform the simple model for the following reasons:

      • Experts have access to qualitative information.

      • Experts have more data.

      • Experts have intuition and experience.

      Of course, there are other ways to support the argument that a human expert will beat a simple model, but most of these stories revolve around the same key points already outlined.

      The following three arguments, however, underlie the expert's hypothesis, and while they are plausible, they are wrong:

      1. Qualitative information increases forecast accuracy.

      2. More information increases forecast accuracy.

      3. Experience and intuition enhance forecast accuracy.

      Remarkably, the evidence we will present illustrates that qualitative information, more information, and experience/intuition do not lead to more accurate or reliable forecasts, but instead lead to poorer decision-making. And because this result is so counterintuitive, it makes it that much more important to understand.

      Among the hundreds of cases of expert forecasts gone awry, one high-profile example is Meredith Whitney.8 Ms. Whitney is famous for her prescient forecast of the banking crisis that reared its ugly head in late 2008. Public accounts of Ms. Whitney's predictions which were widely observed and discussed during that time period, all suggested that Ms. Whitney was a “genius” after her remarkable call on Citibank's balance sheet blues.

      But Ms. Whitney didn't stop there. She outlined her gloomy forecast for the municipal bond market on a December 2010 segment of the prime-time CBS news program 60 Minutes. Ms. Whitney predicted there would be “50 to 100 sizable defaults.” She forcefully reiterated her prediction at the Spring 2012 Grant's Interest Rate Observer Conference, where we observed firsthand the emotional conviction Ms. Whitney felt for her bold prediction.

      However, Ms. Whitney's powers of prediction were fleeting. In an article published in September 2012, the Wall Street Journal published a stinging article titled “Meredith Whitney Blew a Call – And Then Some.” The piece was quick to point out that that “there were just five defaults” in the municipal market.9

      1

      Mick Winstein, “Victor Niederhoffer after He Lost Everything in the 1997 Asian Crisis,” Smarter Investing (June 3, 2013), http://investing.covestor.com/2013/06/victor-niederhoffer-after-he-lost-everything-in-the-1997-asian-crisis-video.

      2

      John

1

Mick Winstein, “Victor Niederhoffer after He Lost Everything in the 1997 Asian Crisis,” Smarter Investing (June 3, 2013), http://investing.covestor.com/2013/06/victor-niederhoffer-after-he-lost-everything-in-the-1997-asian-crisis-video.

2

John Cassidy, “The Blow-Up Artist,” New Yorker Magazine (October 15, 2007).

3

Bill Ziemba, “Hedge Fund Risk, Disasters and Their Prevention,” Wilmott magazine (June 2, 2006), http://www.wilmott.com/pdfs/060206_drz.pdf.

4

R. Ziemba and W. Ziemba, Scenarios for Risk Management and Global Investment Strategies (New York: John Wiley & Sons, 2007).

5

“Mathematics Common Sense and Good Luck: My Life and Careers,” MIT Video (December 9, 2010), http://video.mit.edu/watch/mathematics-common-sense-and-good-luck-my-life-and-careers-9644/.

6

Edward Adelson, “Checkershadow Illusion,” accessed February 10, 2014, http://persci.mit.edu/gallery/checkershadow.

7

Marine Rifle Squad, MCRP 3-11.2, Chapter 5.

8

We do not mean to single out Meredith Whitney. The same point can be made with just about any analyst who has shown up on CBNC and expressed a confident and detailed opinion on a forecast.

9

David Weidner, “Meredith Whitney Blew a Call – And Then Some,” Wall Street Journal (September 27, 2012), http://online.wsj.com/news/articles/SB10000872396390444549204578021380172883800.

8

We do not mean to single out Meredith Whitney. The same point can be made with just about any analyst who has shown up on CBNC and expressed a confident and detailed opinion on a forecast.

9

David Weidner, “Meredith Whitney Blew a Call – And Then Some,” Wall Street Journal (September 27, 2012), http://online.wsj.com/news/articles/SB10000872396390444549204578021380172883800.