The Most Dangerous Math Mistakes Advisors MakeAdvisor Perspectives
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“Any number projected five years into the future is 100% unreliable.” That’s the polite version. Other versions of the “5-100” rule say, “Any number projected five years into the future is 100% BS.”
Another version – “The bottom right corner of a spreadsheet is always a lie.”
Unexamined thinking about where numbers come from and how they work can lead to dangerous math mistakes. This article will show how to make your advice both less precise and more helpful.
The 5-100 rule was one of the first things I learned when I began working as a financial planner in the mid-1980s. Planners had the ability to run insurance projections out 50 years, and our computers could show exactly how much a retirement fund or home would be worth decades into the future. We knew what the rate of growth or inflation had been, or which asset class outperformed which other class, and could assume that the future would continue (or not – it was our choice) on the same path.
The only problem was that none of the answers were valid.
Here are some more things I’ve learned over the years, starting from when people used slide rules [rules, not rulers] instead of calculators, and continuing through decades of working with clients.
Numbers represent reality, but aren’t reality
Except to mathematicians, numbers have interest because they represent real measures and the basis for real-world decisions: how much, how many, how fast, growing at what rate? Each measure is an approximation. To take a simple example, the rate of return for an ETF depends not only on how long it was held, but what time of day it was bought and sold, whether there were any transaction costs and even how many shares were involved.
Numbers are affected by the real world. Tax rates change. Economies grow, or not. New management is brilliant, or criminal. Expansion continues until a market is saturated, or competition intervenes, or customers chase a new shinier object. Quarterly GDP figures and other official statistics are adjusted at least three or four times following the initial reports. When a number is projected into the future, the math may be accurate, but the answers are unlikely to be.
Read the full article here by by Richard E Vodra, Advisor Perspectives