How can finance professionals master superforecasting?

How can finance professionals master superforecasting?

Predicting the future isn't easy, especially when you're working with a volatile economy.

This volatility has made financial forecasting an especially important skill for many businesses.  The latest trend to emerge in this area is 'superforecasting' – harnessing the talents of your very best financial forecasters to gain a competitive edge.

So how can you identify and nurture the superforecasters in your business? And how can finance professionals and CFOs master the art of “super” financial forecasting?

What do superforecasters have in common?

While 'big data' is often touted as a window into the future, we continue to live in an unpredictable world. As the Global Financial Crisis of 2008 showed, data-based forecasts can fail in a big way when it comes to predicting future events. Most never saw the crisis coming, but there were a few who recognised the signs – perhaps the most famous case being Steven Eisman, who successfully shorted sub-prime mortgage stocks by recognising their extremely low inherent value.

Professor Philip Tetlock of the University of Pennsylvania has studied the traits of superforecasters and found that they usually have a few things in common:

  • They break complex problems into smaller, easier-to-solve ones.
  • They compare present events with the outcomes of similar events in the past.
  • They don't over-react to individual pieces of evidence.
  • They are always analysing their mistakes and looking for ways to do things better.

Not everyone can be a superstar at superforecasting, but Tetlock says that there are a few ways in which organisational leaders can turn everyone in their company into better forecasters – and discover who are their true superforecasters are.

Training for better judgement

So, how do you uncover the superforecaster within? According to Tetlock in the Harvard Business Review, we are all prone to basic reasoning errors that can throw our predictions off the mark. Many are the result of basic cognitive biases and emotional triggers that prevent us from being objective or logical. A good example is the gambler's fallacy – expecting a different outcome from a random event based on previous outcomes. For example, if a coin toss results in three heads in a row, that doesn't mean the next toss is more likely to be a tail than a head.

Another common type of predisposition is confirmation bias, which is our tendency to agree with people whose views are compatible with our own. Many people also have a habit of adapting their views to influence others or to protect their reputation – after all, who wants to be the one person who gets it wrong?

Training your staff to recognise their internal biases can have a huge payoff. A Wharton School study found that just an hour of staff training improved the accuracy of people's forecasting by about 14 percent over the course of a year. When applied to finance forecasting, this could translate into huge financial gains.

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Be open to different opinions

As the 2008 Global Financial Crisis showed, sometimes the best predictions are made by the contrarians.

That being said, it's particularly vital that your leading financial superforecasters are domain experts with a firm grasp of various financial concepts such as cash flow, business valuations and cost-of-capital calculations.

However, as Tetlock found in his research, non-experts can still provide valuable input. For example, your customer service manager may have recognised an important consumer trend that your finance team has overlooked, or your IT manager may foresee a technology change that will have major impact on your bottom line.

Whatever the case, creating a “superteam” of superforecasters can multiply the effectiveness of your forecasting activities.

Trust each other and be open to feedback

Superforecasting is one of many finance skills that can be seen as personally risky because the stakes are often high. Whole reputations can be riding on the success or failure of a new business acquisition, or whether it was the right decision to divest a part of the business.

Your superforecasters should feel that they can trust each other and that their management will not react badly if a forecast fails. Tetlock suggests that superforecasting is best performed in an environment where the company's leaders set the strategic course, but empower their employees to make their own decisions.

Superforecasting is a skill worth mastering

Providing timely feedback is essential to improving your forecasting performance in a career in finance. The Brier score – which is calculated by squaring the difference between a probability prediction and the actual outcome – is a good way of finding out who your true superforecasters are.

By recognising and empowering the superforecasters in your midst, you can help yourself and your organisation make better use of its data to predict finance industry trends.

Tags: Finance

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