Saturday, February 13, 2010

Financial News: Worse than Useless!

I first thought I'd title this article Financial News: For Entertainment Only, but then as I thought more about it, I concluded that for most investors, watching or listening to financial news is probably not that entertaining, and more likely is detrimental to their investment success.  If the news is pessimistic, it probably will cause you to worry about your investments, and worst of all, change your rational investment strategy.  If the news is optimistic, it may cause you to be somewhat greedy, and again, change your rational investment strategy (in a different way of course).  As Warren Buffet said, as an investor, you're better off being fearful when others are greedy and greedy when others are fearful; here's the exact quote from his 2004 letter to stockholders"Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful."


So, if you have the discipline and mental fortitude to do the opposite of what the financial news makes you feel like doing, then perhaps it could be useful to you.

Behavioral Finance and Neuroeconomics are fields of academic research on investing that address topics like the one discussed above.  If you want to learn more about how your brain is wired to make bad financial decisions (and how you can combat it), I recommend that you read Jason Zweig's excellent book, Your Money and Your Brain (Learn How the New Science of Neuroeconomics can Help Make You Rich).

Another result of academic research on investing that tells us that we shouldn't pay much attention to financial news is the Efficient Market Hypothesis (EMH).  In its simplest form, it states that all known information is already reflected in market prices (e.g., stock prices).  While there have been criticisms of this theory, if we reflect on it a bit, I think we can conclude that it's unlikely there's anything in the financial news (widely known information) that can help us make investment decisions.  As soon as any financial news is disseminated, thousands of very intelligent, professional investors and traders know about it, and have the opportunity to instantly buy or sell stocks or other investments based on their analysis of the news.  Do we really think that we are somehow smarter than all of these highly skilled traders and investors, and can somehow take advantage of the news in a way that they haven't already?  Consider that for every expert or investor that is predicting doom and gloom, and selling stocks, there's another expert or investor on the other side of the trade, buying the same stocks.

Let's look at a current example: the U.S. budget deficit and debt.

Although I pay almost no attention to financial news (I used to, before I learned that it was bad for me), I do glance at MarketMinder.com now and then, and I hear things from people who are worried about this or that thing they've heard in the news.  A big one now is the large and growing U.S. budget deficit and debt (the trade deficit is another one that people have been worried about for years).  There are all kinds of worries about how this will be bad for stocks (e.g., it will lead to high inflation, which will be bad for stocks).  Don't you think that most investors already know about the deficits, and are investing accordingly?  I'm not saying that deficits definitely won't cause problems down the road, but just that we don't know that for certain (financial history actually indicates otherwise), and that it's unlikely that we can take advantage of this already widely know information to make investment decisions.  

Although it's somewhat of a tangent, here are a few things to consider about the budget deficit and debt.  First, it's not the absolute size of the deficit or debt that matters, but its size relative to GDP, and the ability of the government to service the debt.  Yes, the relative size of the debt is large and growing, but it's not as large as it was in the mid 1940s, yet this period was followed by robust economic and stock market growth.  Also, since bond rates are historically low, it's less expensive for the government to pay interest on new debt.

Historically, large and increasing relative debt does not result in lower stock prices.  Debt as a percentage of GDP increased from 32.6% in 1980 to to 67.2% in 1995, and was at 61.5% in 1999, yet this was the time of the greatest stock bull market in modern history.  In 1970 the debt was only 35.7% of GDP, and decreased to 31.7% in 1974, yet the U.S. stock market (as measured by the S&P 500) lost about 25% during this period.  There are numerous similar examples for both the U.S. and other countries that show that, if anything, increasing government debt is correlated with higher stock prices, and vice versa -- exactly the opposite of what most people seem to believe.

This has been somewhat of a digression from the topic of financial news, but the point is that as an investor, your time is better spent educating yourself on financial and investing history than watching or reading financial news.  To educate yourself more on debt and deficits as they relate to investing, visit MarketMinder.com, and click on Deficits in the TOPICS section on the right of the page (make sure you're on the AT A GLANCE tab).

Another thing to consider about financial news (or any news for that matter), is that the new media's interests are not aligned with your interests as an investor.  The media is in business to make money, not to educate you.  Dramatic headlines capture attention, leading you to read the associated article, and be exposed to the associated advertising.

In most of the investing books on my recommended reading list, you'll find a section or chapter illustrating the hazards of paying attention to financial news and the predictions of experts.  Extensive research has shown that investors do not profit from responding to financial news or following the advice of experts.  In trying to keep this blog relatively simple, I don't provide lots of references, but the books I recommend do.  Rather than spending time watching or reading the financial news, I highly recommend that you spend that time reading a good book to educate yourself on the theory, history, psychology and business of investing.  In doing so, you'll become a better investor, and experience fewer emotional extremes.

However, if you actually find financial news entertaining or interesting, and don't let it worry you, excite you, or influence your investing behavior, then by all means, enjoy it!

4 comments:

  1. Kevin,
    I feel much better after reading this article;especially after seeing that historically, stocks have gone up as we go in debt. I have a bad habit of listening to financial doomsayers which I need to simply stop.
    The only part of my questions that I still ponder on is how so many people were taken off guard by the financial crisis we had?

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  2. Hey Harry,

    Good to hear that this is helping you break your addiction to what some refer to as financial pornography. Although I understand that it's easier to listen to the news or glance at the business section of the newspaper, I'll continue to encourage you to make the extra effort to read good investing books instead.

    People have been being caught off guard by financial crises for hundreds of years. Reading a good book or two that covers this subject helps realize that what we've recently been through isn't all that unique in many respects. William Bernstein's "The Four Pillars of Investing" devotes an entire section to financial history (one of the 4 pillars), reviewing a number of bubbles and crashes that have occurred over the years. I highly recommend this book.

    We've been through two big bubbles/manias and crashes/panics in the U.S. in the last decade or so: the high tech bubble/crash of the late 90s and early 2000s, and the credit/housing bubble/crash recently. It seems that a bubble is by definition something that most people don't realize is happening when it's happening -- otherwise people wouldn't continue to buy assets at inflated prices.

    Clearly there was a lack of transparency in the derivatives markets, and a lack of effective regulation to keep people from getting themselves into trouble. This includes people who bought houses they couldn't afford as well as those who made the loans to them, not to mention those who bought and sold the repackaged loans. While we may or may not get improved regulations to deal with this particular set of problems, human ingenuity is such that it's unlikely we'll ever keep creative people from finding ways to get around the regulations, coming up with exotic financial products, and finding investors to sell them to.

    It's also unlikely that human nature will change much, and that people won't get caught up in the greed that contributes to manias and bubbles, and the fear that exacerbates the ensuing panics and crashes.

    Kevin

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  3. Very well put! I think it's great that you are pointing this out because as you said, it sounds as if people listen too much to financial news and sell when stocks plummet, and buy when stocks rise...I'm glad you're teaching me while I'm young to do the opposite! I also really appreciate the reading references. It's really helpful for people like me who need to learn a little bit more on these subjects.

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  4. This is a fantastic article...Thank you for including the financial history of our country. As for what Harry mentioned, as well, I believe news on any subject feeds off of our most dramatic emotions. If what's going on in the stock market elicits the slightest bit of fear, the news will feed off of this and bring in "experts" to comment and get all of us going crazy. Unfortunately, I think it can be relatively easy these days to get caught up in the mass media craze... Especially when you hear phrases like, "The Great Depression" being thrown around...

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