Here’s a New Year’s resolution for you: Read less market news. It may not be quite the advice you’d expect to read on a personal finance web site, but if you’re cleaning house portfolio-wise this New Year, it may be just the advice you need to hear.
But isn’t more information always better? Won’t a better-informed investor outperform a worse-informed investor? If I know less than the other guy, won’t he have the edge over me?
The answer to all three questions is: no. There was a time when financial news, of a sort, could make or destroy fortunes. That time, however, was before instant communication made the same financial news available to everyone, everywhere, all the time. For instance, in 1790, when Alexander Hamilton announced his plans for the new federal government to assume the states’ debts left over from the Revolutionary War, wily bond speculators were able to travel faster than the news — buying up bonds from uninformed investors at 20-cents-on-the-dollar. They turned a tidy profit.
As you may have noticed, however, we’re a long way from Alexander Hamilton. Now, everyone’s reading off the same page — or the same Bloomberg screen, Twitter account, or news ticker. And, if you do have information that’s truly not available to the rest of the market, chances are you may find yourself on the wrong side of the Securities and Exchange Commission. As for rumors and “hot tips,” sure you could score big, but your odds are just as good to lose big.
Of course, the problem is that everyone’s sure that their hot stock tip, the rumor they heard, or the conclusions they’ve drawn from the latest economic report are more accurate and more brilliant than everyone else’s. We’re all sure we’re from Lake Wobegon; we’re all sure we’re above average.
Even when looking at sheer noise, people are prone to start believing that they can pick out patterns. Take, for example, a classic experiment conducted by Harvard psychology professor Ellen Langer in the 1970s. Using coin tosses — as basic and intuitive an example of random chance as possible — Langer demonstrated that a significant number of people could become convinced that they were able to predict the results of a coin toss better with practice (and that their newly acquired skill could be thrown off by distractions). How could people be so foolish? Essentially, they over-remembered their successes — remembering the times they called the toss right, forgetting the times they called it wrong.
With the stock market, of course, it’s even harder to resist this illusion of control. We’re not talking about a coin toss, we’re talking about actual companies with actual products making actual money. Surely, skill and smarts must matter when picking stocks — even if, as a recent paper by Eugene Fama and Kenneth French found, actively managed mutual funds rarely do better than pure chance (and even then, their management fees erase the difference).
But even if we’re overestimating our abilities, does this really do more damage than being under-informed? The surprising answer is: yes.
In the late 1980s, psychologist Paul Andreassen conducted an experiment on MIT business students. First, he had the students select a stock portfolio. Second, he separated the students into two groups — allowing one group to see only the changes in the prices of their stocks (they couldn’t even see which stocks were going up or down) and allowing the other group unfettered access to financial news. Which group did better? Well, you’re reading this anecdote, so it’s got to be the counter-intuitive one (right?): the group with less information made more than twice as much money as the high-information group.
Why? It seems that the higher-information group became distracted by the constant flow of news. They focused on the latest buzz and rumors to the point where they engaged in far more buying and selling than the low-information group. They thought their knowledge was allowing them to outsmart the market; but they thought wrong.
How can you avoid falling into the same trap as Andreassen’s over-informed students? One starting point: that New Year’s resolution up top, less financial news. More specifically, set a balanced, diversified portfolio and forget it. Severely limit the number of times you check in on it — maybe once at New Years, and then two or three more times spaced throughout the year.
More generally: Try to remember that you’re not as smart as you think you are. There are millions of investors out there who all think they’re smarter than you and than each other. You and they are almost certainly wrong. Some will do better, some will do worse — but far more of it is up to chance than anyone likes to believe.
We’re all battling the same cognitive biases. Every news report is just another chance to lose that battle.
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