Investment Noise

A recent blog, Social Media’s Impact on Financial Decisions, talked about the intersection of investments and social media.  Among other things, social media and the internet are the latest and potentially most pernicious way we can be inundated with financial “noise.” But investment noise searches us out over all forms of media, starting with print and moving through TV, radio and the internet.

One of the biggest challenges we may face as investors is to resist the noise and chatter.

We’ve likely all seen it, whether it’s in the form of sensational headlines on magazine covers and websites or the fast talk, bells and whistles of financial TV shows. Constant updates on company earnings and stock prices, economic releases, and market movements create the impression that all the smart money is nimbly reacting to the latest news and events and positioning portfolios to benefit from them. You should be doing the same or you will be left behind.

That couldn’t be further from the truth.

As we’ve seen in the four years since the financial crisis, the markets are not necessarily in sync with the news—you’ve probably heard the expression “markets climb a wall of worry.” And it turns out it’s not that easy to time the market or pick stocks that will outperform. Very few people have been able to do it consistently, as we’ve seen in many studies showing the inability of active managers to outperform market indices over time. A large majority of equity funds failed to beat their benchmarks for the five years ended 20111:

Equities Failed to Beat Index
Source: Dimensional Fund Advisors; used with permission.

And these are professional money managers who likely have access to every kind of financial information out there and can slice and dice it every which way. Remember, the talking heads with all of their sound bites are in the business of entertainment. TV shows need to attract viewers to attract advertisers. In many instances their goal is to hold an audience, and if they do that best by touting the latest fad or hot stock, so be it. Magazine covers are designed to sell at the newsstand (or on the internet), and the lists of top stocks and best funds that are so rampant in the financial press are constantly changing, enticing readers who don’t want to miss out on the next best thing.

A classic article appeared in Fortune magazine in 1999 under the byline of “One anonymous FORTUNE writer.” In it, the writer tells us, “Mutual funds reporters lead a secret investing life. By day we write ‘Six Funds to Buy NOW!’ We seem to delight in dangerous sectors like technology. We appear fascinated with one-week returns. By night, however, we invest in sensible index funds.”2

Small wonder that individual investors are typically not achieving the returns the markets have to offer.

DALBAR conducts an annual Quantitative Analysis of Investor Behavior. Using mutual fund flows to gauge investor behavior, DALBAR estimates that the equity average investor underperformed the S&P 500 by about 4% annually over the past 20 years.3 The numbers for 2011 were even more extreme, with the average equity investor losing 5.73% while the S&P 500 gained 2.12%.4

It is likely that a lot of fearful investment decisions were made in reaction to ominous headlines and news reports on the euro zone crisis, US and other ratings downgrades, political gridlock, etc. Fund flow data shows $134 billion leaving equity funds in 2011.5

Our previous blog talked about the emotions that can play into investment decisions. That’s the biggest danger of not tuning out the investment chatter all around us—the impulse to do something.

Of course, there are those who benefit from this type of behavior. TV stations attract more viewers with their daily onslaught, and writers sell more magazines with their “What to Do Now” articles. Then brokers and others make money off of the trading of investors impelled to buy the next hot stock or fund. The investor pays for all that activity in the form of trading costs and often taxes, which eat into the returns that are probably sub-par to begin with since the ideas are usually based on information that is already widely discounted by the time it hits the airwaves.

That is not to say there is no useful investment information in the media. There is, and we have unprecedented access to a lot of substantial research and real expert opinion. But diversification, asset allocation and long-term investing are not exactly sexy topics. As the anonymous finance writer put it, “…rational, pro-index-fund stories don’t sell magazines, cause hits on Websites, or boost Nielsen ratings.”6

One of the most important parts of our jobs as advisors is to steer clients away from the chatter and build confidence in their long-term investment program.

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Investment Noise

time to read: 4 min