Are 15% of home borrowers really going to default?

Predictions – from anyone – should be taken with a large dose of salt.

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As is often the case, I was going to write about something else this morning.

And then, the 'news fairy' – as my US colleague Chris Hill calls it – arrived.

The news?

Fund manager Christopher Joye has been reported in today's news as having said that "as many as 15 per cent of borrowers could default before Christmas."

That's around 1 in 7 borrowers.

Which, I don't have to tell you, is a huge number.

Cue the headlines. Cue the concern and fear.

It's not Joye's first negative prediction, though.

A quick Google search shows he's been on a similar train – falling prices and falling affordability – for a couple of years.

But, of course, nothing sells like 'freshness', so a renewed or restated prediction gets the headlines.

Is he right?

I don't know.

No-one does (including him).

I have no doubt that he's sincere and has a high conviction in his view. And I'm sure he's well-informed and has a lot of expertise that he's bringing to bear.

But that doesn't mean he's (necessarily) right.

In part, that's because equally capable, experienced, informed and educated prognosticators have (sometimes very) different, often opposing, views.

They can't – by definition – all be right.

That's the thing about predictions – you only know after the fact who got it right and who got it wrong.

Worse, you can't know whether being 'right' (or wrong) is a function of ability or just plain luck.

If you get one call 'right' after being wrong in the past, you're in coin-toss territory, for example.

Two out of three is still statistically indistinguishable from luck and random chance.

And that should be the first clue that predictions – from anyone – should be taken with a large dose of salt.

There's an old joke that the role of economists is to make meteorologists look good by comparison.

I'm not sure that's right… but I'm not sure it's wrong, either.

Frankly, I don't know why economists and commentators make predictions.

Actually, that's not completely true. I do have my suspicions.

Firstly, because they want to believe they can get these things right. Confidence? Hubris? You choose.

Next, there's real money to be made if they can. So they try.

Third, and related, as John Kenneth Galbraith famously said, "Pundits forecast not because they know, but because they are asked". Worse, for many it's in the job description.

Fourth, and related to all of the above, with all of the historical and current data at their disposal, it makes sense that they believe it must be possible. If only they can work out the relationship between all of the data, and find some historical pattern, and put it into their models, and allow for the changes and…

… and hope they get it right more often than not.

So where does that leave us?

Do you listen to the optimists, and risk suffering losses?

Do you listen to the pessimists and risk losing out on gains?

You might guess what I'm going to say, next.

I ignore them all.

And I'm fortunate. My job description doesn't include having to make forecasts. So, when I'm asked, my usual reply is 'I don't know, and nor does anyone else'.

In this arena, my personal approach (taken from many others, who've said the same thing) is to 'prepare, don't predict'.

But prepare for what? Triumph? Disaster?

Yes.

Huh? Which one?

Both.

So let's unpack that a little.

'Preparing' for something to happen isn't the same as 'predicting' it and organising your portfolio specifically for that singular outcome. That's prediction.

Instead, 'preparing' is about making sure that, no matter what happens, you'll be okay.

Over time, better than okay.

And – this is important – it's a question of doing it on a portfolio level, not company-by-company.

(I'll come back to housing.)

You shouldn't have a portfolio that only does well if a specific outcome (or set of outcomes) occurs, over the long term.

If you're going to make – or lose – a lot, based on where interest rates, or commodity prices, or something else go… you're probably taking way too much risk.

Instead, I think a portfolio should be built to do two things:

1. Not risk permanent loss if certain things do come to pass; and

2. Compound at attractive rates, over the long term, regardless of short-term volatility.

Here's the thing you really, really need to know: there will always be periods of negative returns.

They're not optional. There is no magic formula to avoid them.

But also, remember this: the ASX has always gone to higher and higher levels, over time, despite those periods of negative returns.

Despite the COVID pandemic.

Despite the GFC

Despite the dot.com crash.

Despite the early 1990s recession.

Despite the 1987 crash.

Despite the last bout of this sort of inflation, in the early 1980s.

You get the picture.

I don't know if Christopher Joye is right.

It does make mathematical sense that higher interest rates lead to lower prices.

And it makes mathematical sense that higher rates will suck up more and more of someone's income, and some people will find themselves in over their heads.

That's not a prediction – it's just maths.

And we don't know how many. We don't know for how long. We don't know where rates will top out, or how quickly rates will come back down.

If you're in financial stress right now, please, for the love of God, go and see a not-for-profit financial counsellor and get help. Please! Your best chance of getting out of trouble is acting early.

For the rest of us, we can expect more economic volatility. Because… that's what economies do.

So.. don't overextend yourself. Don't make bets on what might happen next. Don't take silly risks.

Instead, put the power of long term compounding on your side.

Diversify.

Add regularly, in good times and bad.

Expect volatility.

But know that, over time, the returns for ASX investors have been very, very good. I see no reason why the future should diverge meaningfully from the past.

You just have to invest sensibly… and stay the course.

Fool on!

Motley Fool contributor Scott Phillips has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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