Some recent articles by our favorite writers – Grahamites and Science of Hitting – got us thinking about an issue we write about every three or four years – emotions and data in investing. It seems about the time of every market top (or at least 6 of the last 3….), we write an article on the ability to face down your own fears and make money the only way great investors do – purchasing stocks at a substantial discount to fair value. It seems so easy. Wait for a really significant correction, step in, and purchase some great stocks. The rest is investment history. Or at least that's what they say.
Reality has a way of getting in the way of such elucidated thinking. The bottom line is that the vast majority of investors take in far too much information, overreact far too vividly to too much data, blame others for their poor results, and begin the cycle all over again. For the first instance, in a classic study by Richard Thaler, subjects managed an imaginary college endowment consisting of two mutual funds. They could choose how often they received information about fund performance and how often they could trade. The experiment simulated 25 years of investing. The results were clear - participants who received information once every five years, and could trade only that often, earned returns that were more than twice those of participants who were updated monthly and could trade that frequently. The bottom line was that the frequency and amount of data availability directly correlated to poorer returns.
Not only do investors who receive too much data trade more frequently and obtain worse returns, their emotions generally proceed in a rather standard format, rising from a state of panic to euphoria. You can imagine where the latter leaves us in the market cycle.
We live in an age where information is available 24/7. Most of this information provides absolutely no function in evaluating value of our specific holdings. More importantly, the information is provided in a format as to play on our emotions. Finally, we live with a human brain that looks in every possible way to blame others for our failures yet make us feel like genius for our successes. These three factors play an inordinate role in the truly horrific losses occurred every so often when we face significant market corrections. By limiting our data intake, creating models with our own intellect focused on value, and building systems to minimize emotional responses, we can prevent such losses.