What can economists and investors learn from meteorologists? Economics and finance professors in the Tippie College of Business at the University of Iowa are researching whether using multiple economic and financial models running concurrently can deliver more accurate economic forecasts than one model can. Of course, the concept of relying on a pool of models to predict the future has its roots in weather forecasting.
The researchers recently ran a series of “model pools” to see how they would predict returns on stock portfolios between 1932 and 2008. After comparing the prediction to actual market performance, they found that a two-model pool led to more accurate predictions than any one model. Better yet? The three-model pool.
Thus, the researchers concluded that model pooling can potentially produce more accurate predictions for a wide range of economic forecasts, whether it’s charting real estate values or tracking changes in unemployment.
Here’s my take: Modeling to control risk has its place, but when it comes to your portfolio, the best defense against market volatility is to maintain a diversified portfolio, stay true to your asset allocation, utilize low-cost investments, and periodically review and rebalance your portfolio.