Monday, July 1, 2013

The Danger of Too Much Information

In yesterday's note, I highlighted Jason Zweig's column in last weekend's Wall Street Journal.

The theme of Zweig's piece - titled "The Intelligent Investor: Saving Investors from Themselves" - was essentially that investors are their own worst enemies in achieving financial success.

He wrote:

In practice, for most of the media, that requires telling people to buy Internet stocks in 1999 and early 2000; explaining, in 2005 and 2006, how to “flip” houses; in 2008 and 2009, it meant telling people to dump their stocks and even to buy “leveraged inverse” exchange-traded funds that made explosively risky bets against stocks; and ever since 2008, it has meant touting bonds and the “safety trade” like high-dividend-paying stocks and so-called minimum-volatility stocks.

It’s no wonder that, as brilliant research by the psychologist Paul Andreassen showed many years ago, people who receive frequent news updates on their investments earn lower returns than those who get no news. It’s also no wonder that the media has ignored those findings. Not many people care to admit that they spend their careers being part of the problem instead of trying to be part of the solution.

My job, as I see it, is to learn from other people’s mistakes and from my own. Above all, it means trying to save people from themselves. As the founder of security analysis, Benjamin Graham, wrote in The Intelligent Investor in 1949: “The investor’s chief problem – and even his worst enemy – is likely to be himself.”

I did a little research on Paul Andreassen.  Turns out the experiment that Zweig references was actually done in the late 1980's.

A Google search on Andreassen cited a number of different publications discussing the psychologist's work.  Here's a good summary from a Fast Times article published in 2002:

The barrage of information and pseudo-information has been magnified by the explosion in financial news over the past decade. In the late 1980s, psychologist Paul B. Andreassen did a series of experiments with business students at MIT that showed that more news does not necessarily translate into better information. Andreassen divided students into two groups. Each group selected a portfolio of stocks and knew enough about each stock to come up with what seemed like a fair price for it. Then Andreassen allowed one group to see only the changes in the prices of its stocks. Students in that group could buy and sell if they wanted, but all they knew was whether the price of a stock had gone up or down. The second group was allowed to see the changes in price and was also given a constant stream of financial news that supposedly explained what was happening with each stock. Surprisingly, the less-informed group did far better than the group that was given all the news.

The reason, Andreassen suggested, was that news reports tend to overplay the importance of any particular piece of information. When a stock fell, its fall was typically portrayed as a sign that further trouble lay in wait, while a stock that was on the rise seemed to promise nothing but blue skies ahead. As a result, the students who had access to the news overreacted. Because they took each piece of information as excessively meaningful, they bought and sold far more frequently than the people who were just looking at the price.