Traders work on the floor of the New York Stock Exchange on Dec. 4. How you use the overabundance of investment information that exists today is key.Richard Drew/The Associated Press
John Reese is CEO of Validea.com and Validea Capital, and portfolio manager for the National Bank Consensus funds. Globe Investor has a distribution agreement with Validea.ca, a premium Canadian stock screen service. Try it.
Every day, millions of people scroll through financial websites, looking for the latest market news and, hopefully, some good advice as to how to invest in an incredibly complex world. Amid all of the market's chaos, investors want knowledge. They want understanding. They want clarity.
So I couldn't help but chuckle when I recently came across these two headlines, sitting side by side, on one major financial site:
"$26 Crude Oil Coming? That's What This Chart Says"
"Why Oil Could Soar Past $80 Per Barrel"
Well, that certainly creates a conundrum.
Financial news outlets play an important role – their job is to report the news and opinions of the day, and given how much news and how many pundits are out there, you're bound to run into conflicting opinions – sometimes from very intelligent, reputable people.
But these polar opposite headlines highlight a dangerous trap for investors. We humans are attracted to big, bold, shiny objects, and headlines are the big, bold, shiny objects of the news world. They grab our attention – and the bolder they are, the more attention we give them. Then, once we are drawn in, we get plenty of information supporting the idea or opinion touted in the headline. Read an article with the headline, "ECB Decision Means Big Trouble For Euro Stocks," for example, and you'll likely find a plausible argument supported by quotes from money managers, and perhaps some data that appear to back up the thesis as well.
But in an arena as complex as the stock market, there are always two sides to an issue – and sometimes many more – and you can almost always find data to support any of those sides. So, as convincing as they may be, a particular headline and article can lead you into big trouble if you let them guide your investment decisions.
That doesn't mean you should ignore the financial news. Information is still power. But how you use the overabundance of information that exists today is key. Here are a few tips for how to navigate the crowded sea of information.
1. Be a fox, not a hedgehog
The point of gathering information is to better predict future events. The problem is that history shows humans are rather terrible predictors of future events. Philip Tetlock's 2005 book Expert Political Judgment: How Good Is It? How Can We Know? examined a seven-year study he conducted in which supposed experts and non-experts were asked to predict an array of political and economic events. His findings: While the "experts" tended to beat the non-experts, the best human forecasters "were hard-pressed to predict more than 20 per cent of the total variability in outcomes" of events.
But Dr. Tetlock, a psychologist and management professor, did find that some types of forecasters are better than others. Using terms that philosopher Isaiah Berlin used to describe two broad types of thinkers, Dr. Tetlock said that "foxes" did better than "hedgehogs." "The better forecasters were like [Berlin's] foxes: self-critical, eclectic thinkers who were willing to update their beliefs when faced with contrary evidence, were doubtful of grand schemes and were rather modest about their predictive ability," Dr. Tetlock told Money magazine. The less successful forecasters were like hedgehogs, which " 'know one big thing,' toil devotedly within one tradition, and reach for formulaic solutions to ill-defined problems."
How do you think like a fox? Gather as much information as you can before making a decision, particularly information representing opposing viewpoints. When you have an opinion, ask yourself, "How might I be wrong?"
2. Consider the track records
When you read an article that quotes an investment strategist, it's easy to assume the strategist is a good one. That's not always the case. Sometimes they are those who provide the most entertaining commentary, or those who do the best job of marketing themselves.
So, before buying in to what a particular strategist says, check out his or her track record. If the person manages a fund, look up the fund's historical returns. Search the Internet for past interviews the person has given, and see how his or her predictions have turned out. If the strategist has a good track record, give his or her opinion more weight in your decision-making process.
3. Stick to the numbers
The amount of research required to really get a handle on a particular issue can be daunting. And sometimes, no matter how much you read and how successful the people you listen to are, you're not going to get a clear answer on how to proceed. That's why I think most investors are better off using a quantitative system that focuses on the fundamentals and financials of individual stocks rather than subjective, qualitative issues. If you choose a sound strategy that has a good track record, you give yourself a good chance of succeeding over the long haul.
In my own approach, I combine numbers 2 and 3 on this list by using quantitative stock-picking models inspired by investors with proven track records – Warren Buffett, Ben Graham, Peter Lynch, John Neff, Joel Greenblatt and others. I don't rely on headlines, but rather the cold hard financials and valuations that each model looks at.
And when I consider portfolio management issues, such as how often to rebalance or what weight to give each strategy in my portfolios, I try to think like a fox, not a hedgehog. Incorporating these three general concepts into your portfolio management can help greatly over the long haul, regardless of the specifics of your approach.