I love Warren Buffet’s quote, “the worst mistake you can make in stocks is to buy or sell based on current headlines.”
Let me explain why this blunder is so problematic.
Known as a ‘recency bias’ by psychologists, we have a tendency to remember our more recent experiences and perceive them as most important. We often forget about experiences from the past. In investing, this can lead to over-generalizing current market conditions and envisioning them being the same well into the future. This also means that we can forget that when bad times hit, this can trigger problem solving and in the good times, we can be prompted to take more risks.
A perfect example of this can be seen if we look at the business news. The newspaper business thrives on their ability to catch our attention and keep us reading. What sells is excitement, so what I may call a bump in the road is labelled by the newspaper as a crisis. Therefore, in contrast, everything else is promoted as experiencing “explosive growth”.
This may sell newspapers, but if we all buy into the stories and we all either buy or sell when a sensational headline appears, we are more likely to purchase an overvalued stock or sell one when it is undervalued.
When we see exciting headlines, it is human nature to want to take action rather than sit back and do nothing. However, if we take action unnecessarily, the brokerage fees will eat into our returns.
I don’t want to discount the value of the news as being valuable when it comes to assessing a company. The news can alert us to events such as a large merger or fraud that has been uncovered and can be helpful in our decision making process. However, in most cases, the news reports on short-term earnings changes, which is not a good predictor of the value of a company a decade into the future.
Tips for staying sane in a world of headlines
The experience of recency bias is a part of human nature and completely avoiding the business news is not an option as an investor. So, what can we do to make sure that the headlines can create opportunities for us and not create more problems?
1. Focus on the long-term- Will what happened in the markets today matter in 5 or 10 years from now? In most cases, it will not. However, what will matter is where a stock’s current share price stands relative its intrinsic value, which is a function of all the cash it will throw off between now and the future. So much can occur in that time so when reading a headline we must always ask ourselves whether the conditions of today are going to be the same years into the future.
2. Don’t rush- Emotions can get the best of us and immediately acting upon advice can land us in hot water. Emotions can cloud our judgement, so the best way to handle advice is to sit with it for a few days. We can then revisit it and see if we still feel as strongly as we did previously. Ask ourselves, what is the likelihood that today is the day that a stock has hit its ultimate rock bottom or that it will keep moving upwards forever.
3. When everyone is panicking- buy- It isn’t hard to get caught up in media mania, so if we find ourselves stuck, remind ourselves that in the short-term, the market will fluctuate regularly. The good news is that if we buy stocks in high-quality companies when they are undervalued, we will be making the volatility work for you. When the headlines are predicting disaster and everyone is acting on their emotions, we can feel confident that in the long run, we have made the best decision for our investment portfolio.
Stick with these three simple tips and you will be well ahead of the typical investor running around like a headless chook…