If you’re like most people, you probably consider being well-informed a positive attribute. And for good reason — making well-informed decisions is important to avoid costly mistakes. But is it possible to have too much information? When it comes to the financial news, research indicates that it is.
How News Affects Investor Behavior
Harvard psychologist Paul Andreassen conducted an experiment with MIT business school students in the late 1980s, and his findings offer insight into how financial news affects investor behavior. In this study, Andreassen asked the students to analyze financial information and decide if they would buy or sell a stock with relatively low price volatility. The experiment used real news reports and actual prices of real stocks to simulate live investment decisions.
One group of students received access to stock price data as well as a constant stream of financial news reports about the company, while a second group received access only to stock price data. The study found that the group with access to a constant stream of news fared worse as investors than the group that had access only to price data.
The study also found that stock price volatility amplified financial news's negative effect on investor returns. When a high-volatility stock replaced the low-volatility stock, the investor group without access to the news generated a return that was double the return of the group with access to the news.1
Unimportant Information Can Cloud Reasoning
The results of the study seem counterintuitive — how can having more information hurt investor returns?
Investors may feel that random, insignificant events warrant changes to an investment portfolio, and that can hurt their investment returns. Focusing on the fundamentals can be more difficult with so much extraneous financial news floating around.
Does this mean that successful investors never follow the financial news? Certainly not. Astute investors are adept at distinguishing valuable information and tuning out the noise. However, sticking to investing fundamentals can be difficult after seeing dire headlines or hearing experts predict new economic trends. Unfortunately, this kind of news can be a source of distraction that can also lead to a dangerous sense of overconfidence.
The Experts Are Often Wrong
Keep in mind that even experts often fail when trying to predict the future.
For example, Philip Tetlock, a psychology professor at the University of Pennsylvania, shares in his book, “Expert Political Judgment,” pioneering research he conducted on the effectiveness of experts. His study found that experts in a variety of fields fail to make predictions any more accurate than numbers selected at random. This research also indicates that the experts who are the most confident are also the most likely to be wrong.
In fact, Tetlock found the only effective factor in determining the accuracy of predictions is fame, although fame is negatively correlated with accuracy.2 So, consider taking doomsday forecasts in the media with a grain of salt.
Reduce and Filter Out the Noise
Successful investing isn’t easy, and there is always someone tempting investors with seemingly easy solutions to difficult questions. Ultimately, investors who allow social media or the financial news to influence their stock investment decisions can impair their returns. Since research indicates that your portfolio will fare better if you do not follow financial news, consider staying away from media that revolves around stock market programming.
When you do consume financial media, be skeptical of predictions. Remind yourself that financial fundamentals are more important than news. This is more critical than ever in an election year, when the effect of U.S. presidential elections on stock market returns may be exaggerated.
If you need help distinguishing between important information and noise, consider consulting a CERTIFIED FINANCIAL PLANNERTM professional who can help you focus on the fundamentals and make decisions that align with your financial goals. Find your CFP® professional today.
Footnotes:
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1 Gary Belsky & Thomas Gilovich, Why Smart People Make Big Money Mistakes and How to Correct Them (Simon & Schuster, 1999), 168
- 2 Larry Swedroe, Investment Mistakes Even Smart Investors Make and How to Avoid Them (McGraw Hill, 2012), 28 - 31
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