Posted by on Nov 7, 2016 in Articles & Advice, Blog, Columns, Featured, Posts |

By Jason Zweig | Nov. 7, 2016 9:20 pm ET

Image credit: Carol M. Highsmith, “The Three Gossips (Rock Formation, Arches National Park, Utah), Library of Congress

 

With Election Day upon us and almost everyone I encounter seemingly glued to the news, even as millions of Americans revile the media, this seemed a timely moment to post an article I originally wrote nearly 20 years ago on how to consume the news without being consumed by it.  

 

 

Here’s How to Use the News and Tune Out the Noise

Jason Zweig | Money Magazine, July 1998

I hate to seem as if I’m raining on my own parade, but recent events have me wondering: Is there such a thing as paying too much attention to the financial press? Are investors today better informed than they used to be — or have they become too well informed?

Last December, Warner-Lambert stock lost 18.5% of its value, or $7 billion, in a single day when a British company said it would stop selling a Warner-Lambert diabetes treatment. But over the next three months, Warner-Lambert sold $138 million worth of that drug — plus $1 billion worth of others — and the stock gained a third, outperforming the market by nearly three to one.

In May, the stock of Entremed, an obscure biotech company, shot from $12 to $85 in a day when the New York Times reported that two of the firm’s drugs showed promise as cancer cures. Fidelity Select Biotechnology, a fund that specializes in similar stocks — but didn’t hold Entremed — jumped 1% that day as its holdings rose in sympathy. Then the reality sank in that the drugs have worked only on mice; the stock shrank back below $30, and the Fidelity fund lost value for the week. Only a few days after it broke the front-page news, the New York Times ran two articles scolding investors for not realizing that Entremed’s prospects were not that bright after all.

In both cases, traders who acted on the first burst of news ended up kicking themselves. Why? Because these days, news reaches everyone so swiftly that it’s almost impossible to beat the stampede. It wasn’t always this way.

Back in 1790, as soon as Alexander Hamilton released his plan to reorganize U.S. debt, crafty bond speculators sailed south from New York in sleek ships that outraced the good news on land. Those speculators snapped up bonds from uninformed small investors at 20[cents] to 25[cents] on the dollar, and within days, they were able to double their money. Likewise, in 1815 financier N.M. Rothschild made a fortune buying English bonds after his elite private couriers slipped him the first word that the British had defeated Napoleon at Waterloo.

In Hamilton’s and Rothschild’s time, news took days to travel from Paris to London or New York to Philadelphia, giving clever investors a chance to get the word and act on it before anyone else. But today, over the Internet and CNBC, news flits from Jakarta to Chicago in nanoseconds — and professional and amateur investors alike can follow every twitch in a stock as closely and easily as intensive-care doctors monitor changes in a patient’s pulse.

Mind you, it’s still possible to get wind of big news before most people do. This May, the Internet chat rooms were rife with rumors that Tyco International was about to acquire U.S. Surgical. If you’d pounced on U.S. Surgical when the rumors first surfaced, you could — in theory — have earned more than 25% in just 12 trading days.

But in truth, investing is rarely that easy: First, the Tyco rumor was fueled by what appears to be inside information–not the kind of thing you often can get hold of legally. Second, for every online rumor that turns out to be true, there are scads of them that turn out to be false. Datek, the Internet brokerage firm, says in its ads: “Big news can mean big opportunity. Points can be made in a heartbeat.” But at least as often, big news can be flat-out wrong–and points can be lost in a heartbeat.

The bottom line: It’s the very urge to act on the financial news that gets many investors in trouble. A decade ago, Paul Andreassen, a psychologist then at Harvard University, designed a series of laboratory experiments to learn how investors respond to financial news. So far as I know, Andreassen’s studies have never been described in a personal-finance publication — perhaps because they appeared in such arcane journals as Organizational Behavior and Human Decision Processes, or perhaps because they imply that we in the press do not always serve investors well.

It seems obvious that investors who are better informed will earn higher returns than those in the dark. But Andreassen found the opposite: Among buyers of more volatile stocks, those who ignored the news earned more than twice as much as the news junkies.

When you think about this, it makes perfect sense. In our race to bring you the latest scoop, we in the financial media tend to isolate recent changes, rather than put them in context. In fact, the flow of the news makes trends seem likely to persist just when they are most likely to reverse.

Think, for example, of the glowing media coverage that Iomega, Oxford Health and Cendant got as their stocks were shooting almost straight up — and how, once the stocks stumbled, nobody in the press could find anything good to say about them anymore.

Or consider fund managers Gary Pilgrim of PBHG and Garrett Van Wagoner of the Van Wagoner funds: After huge gains in 1995 and early 1996, they were written up as if they could walk on water wearing lead boots. Now the media often treat Pilgrim and Van Wagoner as if they’re simply all wet.

That’s because reporters, like most humans, fall into the trap of assuming that we can predict future results by analyzing recent patterns. Thus we tend to reinforce the notion that “when you’re hot, you’re hot — and when you’re not, you’re not.”

Unfortunately, a stock is no more certain to keep rising just because it has been going up lately, nor is a mutual fund more likely to beat the market this year because it did so the past few years. In fact, finance professors have amassed overwhelming evidence proving the opposite.

Also, the press usually focuses on the numerical amount of a price change, rather than on its value in percentage terms (which is what really matters). Thus a TV reporter may exclaim: “The market is dropping — the Dow is down 100 points!” even though, at the recent 9000 level of the Dow Jones industrial average, that’s barely a 1% drop.

Now think how odd it would sound if the weatherman on the same TV station hollered, “It’s getting colder — the temperature has fallen from 91° to 90°!” That too is roughly a 1% drop.

When we watch the market, much of what seems like news turns out to be nothing more than noise. A year ago the press was nearly unanimous in declaring Southeast Asia to be one of the world’s best long-term investments; next, when the Asian Tiger markets collapsed last fall, you were advised to bail out; then, when those markets bounced up early this year, the coverage waxed bullish again; and now, with Asia in retreat, the news is back to bearish. Trying to follow all this is enough to give you whiplash — and to distract you from the key question: If Asia was a good long-term investment a year ago, isn’t it an even better value today at half the price?

Listen to Charles Ellis of Greenwich Associates, the distinguished investment management consultant: “The typical stock price changes by at least 4% between its high and low each day. Since there are roughly 250 trading days per year, that implies a total price change of 1,000% per year. But the price of most stocks actually changes less than 15% per year on average, which means that more than 98% of all the movement is just flutter, or noise.”

So how can you tune out the noise?

Stop checking your watch. Many people would panic if they did not know, day by day or even moment to moment, the exact prices of their investments. This impulse is understandable: It’s your money. But the more you check your investments, the more they’ll seem to bounce up and down. By contrast, you probably don’t check the value of your biggest investment, your house, on a daily or weekly basis. Does that prevent your house from rising in value over time? Does it make you a poorly informed real estate investor? Of course not. And you should think of your portfolio the same way. Personally, I check my mutual funds four times a year — no more, and no less.

How much trouble can you get into by obsessing over short-term price changes? Plenty. Recent research by a team of economists and psychologists compared allocations between one stock fund and one bond fund among two groups of investors: those who evaluate their portfolios monthly and those who look at their accounts once a year. The monthly group watched the stock fund heave up and down 12 times, while the yearly group saw it change only once, at year-end.

The monthly group, fixating on the interim volatility of the stock fund, moved money into the lower-earning bond fund; the yearly group stuck with the stock fund, ending up with twice as much money in equities. “The [investors] with the most data did the worst in terms of money earned,” wrote researchers Richard Thaler, Amos Tversky, Daniel Kahneman and Alan Schwartz in the Quarterly Journal of Economics last year. The lesson: Stop checking your watch so often.

Investing is a marathon, not a sprint. Entremed, that little biotech company with the promising cancer cure, may well be the next Pfizer. But history shows that the company that comes up with a breakthrough is not always the one that profits. After all, the fax machine was pioneered by Western Union, commercial air travel by Pan Am, the VCR by Ampex and the personal computer by Commodore. All of these innovative firms lost out to the copycat companies that followed them. That’s why you should never rush to buy a stock “on the news”; if the breakthrough is that great, the company has years of growth to come, and you can take your time evaluating it. And that’s where the press can come in handy.

Finally, remember the difference between the weather and the climate. On any given day, it can be warm and sunny or dark and rainy. But in the long run, the climate is more predictable. Investing is like that too: Just as June tends to be warmer than January and August sunnier than April, over longer periods investment fluctuations smooth themselves into more foreseeable patterns. Although the market news can be alarming on any day — or, as in the 1970s, awful for several years — over time it will turn more comforting as the value of your investments grows.

Source: Money Magazine, July 1998

Note: I would write this a bit differently today (the evidence for persistence in short-term performance, or “momentum,” appears to be stronger than I suggested, and the anecdote about Rothschild is disputed by some historians), but I wouldn’t change much else.
For further reading:

 

Related:
Chapter Two, “‘Thinking’ and ‘Feeling’,” in Your Money and Your Brain