1/
Get a cup of coffee.
In this thread, I'll help you understand the basics of Binomial Thinking.
The future is always uncertain. There are many different ways it can unfold -- some more likely than others. Binomial thinking helps us embrace this view.
2/
The S&P 500 index is at ~3768 today.
Suppose we want to predict where it will be 10 years from now.
Historically, we know that this index has returned ~10% per year.
If we simply extrapolate this, we get an estimate of ~9773 for the index 10 years from now:
3/
What we just did is called a "point estimate" -- a prediction about the future that's a single number (9773).
But of course, we know the future is uncertain. It's impossible to predict it so precisely.
So, there's a sense of *false precision* in point estimates like this.
4/
To emphasize the uncertainty inherent in such predictions, a better approach is to predict a *range* of values rather than a single number.
For example, we may say the index will return somewhere in the *range* of 8% to 12% (instead of a fixed 10%) per year.
5/
10 years from now, this implies an index value in the *range* [8135, 11703]:
