May 20, 2021

The Signals & Media Noise: Part 1

By Michael McKeown, CFA, CPA - Chief Investment Officer

The Signals & Media Noise: Part 1

Financial media appeal to our emotions. That translates into clicks from readers. More clicks means more money.

There is an entire field of study dedicated to emotion and money. It is called behavioral finance. 

The foundation of economics used to be “rational man.” That is, always and everywhere, people make rational decisions.

Behavioral finance thoroughly debunked this. 

Loss aversion is a common bias. Nobel Prize winner Daniel Kahneman performed an experiment to demonstrate. The experiment involved asking people if they would accept a bet based on the flip of a coin. If the coin came up tails the person would lose $100, and if it came up heads they would win $200. The experiment showed that, on average, people needed the opportunity to gain about twice as much as they were willing to lose in order to proceed with the bet.

This proved that the pain of a loss outweighs the euphoria of a gain of the same amount.

As portfolios grow, decisions become more difficult. Loss aversion increases as the stakes of an investor’s choice becomes larger.

Following market recoveries, the media talk about how much money investors are making. People have the ‘”fear of missing out.”  After market volatility, the stories of turmoil and crisis grab headlines. People have the fear of losing.

It is much more noise than signal.

Everyone is susceptible to the biases studied by behavioral finance.  Even financial professionals.

The Investors Intelligence Survey asks advisors if they are bullish (positive) or bearish (negative) on the market each week.  Usually, bulls outnumber bears. The rare instances where bears outnumber bulls tend to be much closer to the bottom of the market than the top.  Note the trough in the S&P 500 Index with the vertical grey bars in the years of 2011, 2015-2016, and 2020.

Checking deposits

Who wants to read the following headline? “Diversified portfolio helps retiree reach spending needs.” That is so boring.

It does not appeal to emotion.

There are plenty of stories in the headlines today – inflation, cryptocurrency, volatility.  These appeal to fear and greed, the emotions that get more clicks.

It is far better for investors to block out the noise, focusing on the signals that lead to long-term success.

In Part 2 of this series next week, we will dive into the signals investors can use across investments.

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