Amid tariff wars and temporary truces, Brexit bewilderment, and the Fed potentially lowering the federal funds rate, we continue to stay the course and capture market returns.
You probably already agree it makes sense to ignore noisy distractions in pursuit of your financial goals. But how do you know what is noise and what is substance?
One of my favorite behavioral economists, Daniel Kahneman, offers us important insights on this front. In an October 2016 Harvard Business Review Article, which you can find below, noise is given an apt definition.
They define noise as how widely different people’s interpretations of the exact same information tends to vary. When judgments based on the same data vary by a lot, they’re considered noisy … because how do you know who’s right?
For example, as reported in the HBR article, Kahneman and colleagues measured the noise levels at two financial service organizations by presenting identical case studies to multiple participants at each firm. The firms’ executives predicted judgments might vary 5%–10% of the time. Instead, on average, different professionals’ judgments varied between 48%–60% of the time.
This outcome is not exclusive to financial types. Kahneman found similar results across different professions, including doctors, judges, loan officers, and other professionals. The bottom line is that even educated judgments can be very “noisy,” and that’s before we even consider the discussions we’re subjected to daily from a never-ending feed of often insignificant information.
As Kahneman describes, “The problem is that humans are unreliable decision makers; their judgments are strongly influenced by irrelevant factors, such as their current mood, the time since their last meal, and the weather. … Whenever there is judgment there is noise and probably a lot more than you think.”
Let’s bring this back to investing. Does this mean everything you hear is noise, and nobody knows what’s going on? In terms of breaking news, it probably does. That’s why it’s all the more important to heed these pointers:
- Be disciplined. Kahneman refers to using algorithms, or evidence-based rules, for quieter, more consistent outcomes. Following such rules may not deliver as hoped for every time, but it should outperform excessive judgments (even from the “experts”).
- Think big-picture. Kahneman suggests: “See the decision as a member of a class of decisions that you’ll probably have to take.” This includes avoiding regret over past outcomes as “probably the greatest enemy of good decision-making in personal finance.”
- Be open to noise-dampening advice. Seek advice that helps you tune out rather than amplify judgmental noise. As Kahneman describes, a good advisor is a “person who likes you and doesn’t care about your feelings.”
Okay, we do care about your feelings, but our number one goal is to provide relevant and useful advice so you can make smart decisions.