“Too much information” often refers to inappropriately sharing undue personal details, but TMI can also ruin your portfolio. TMI is very much a Wall Street problem, where it poses a completely different kind of challenge: Analysts are paralyzed by the relentless search for more and more information, in the hope that one more. numerical or econometric analysis will bring that important advantage.
Researchers have found that not only does this task quickly reach the point of diminishing returns, but it actually turns out to be counterproductive. In other words, the perfection is the enemy of the good. You will likely do better over time by choosing a suitable strategy and following it disciplined rather than constantly guessing about your chosen strategy in hopes of perfecting it.
One of the best illustrations of this phenomenon is a study done almost 50 years ago by Paul Slovic, professor of psychology at the University of Oregon. (I have been prompted about this study by one Recent post on Macro OpsSlovic sets the goal of measuring whether our predictions become more accurate as we analyze more and more pieces of information. He found that they didn’t.
Slovic reached this conclusion when analyzing a group of professional equine disabilities selected for their specialty. They are presented with a list of 88 variables from which they can choose a few as the basis for their prediction of which horse will win in different 10 horse races. For a racial group, they were only allowed to choose five out of those 88 variables. They are allowed to focus on the variables gradually in the second, third, and fourth sets – 10, 20, and 40, respectively.
Slovic found that the average success rates of these handicap players stayed the same across all four rounds – 17%. Their success rate, on the other hand, is impressive, because if they’re not better than a coin flip, you can expect them to be only 10% of the time. On the other hand, the increase in the number of variables did not affect their prediction success.
That’s serious enough, but what Slovic measures next is really disappointing. In each of the four races, he asked those who accepted their belief in the accuracy of their predictions. As you can see from the chart below, their confidence level has increased dramatically as they are able to focus on more and more variables. So the real effect of complementary analysis that acceptors can conduct is becoming more and more confident.
To be sure, Slovic quickly admitted, horse racing is not like investing. But they are not as different as many investors would like to admit. Horse racing has newsletters and suggested flyers, just like investing. The horse racing newsletter is filled with tables and charts that analyze and learn about each horse’s past performance. “It doesn’t take too much imagination to see parallels between these types of charts and the data sources used in some form of financial analysis,” writes Slovic.
Trend of validation
You might wonder why professional handicap gamblers don’t improve their predictability by focusing on more variables. One answer, as outlined in the Macro Ops article, is what’s called the confirmation bias – defined by Wikipedia is “the tendency to seek, interpret, prioritize and recall information in an affirmative or supportive manner faith or values. “
Here’s how that might work: Once they got to know their five favorite variables, the acceptors made at least one tentative conclusion about the horses they wanted to bet on. When the additional variables above and beyond those five indicate the same conclusion, the acceptors become more confident that their original judgment was correct. When additional variables point to another prediction, they either give them less weight or ignore them altogether.
Of course, confirmation bias is also common in the stock market. Investment stimulates anxiety, so it is only natural that we attract arguments and research that confirm our current outlook. This process usually takes place unconsciously, but almost all of us have it. The bulls seek justifications for the upside even as the bears are looking for justifications as to why they should be bearish.
Having spent more than 40 years following the daily arguments of hundreds of investment newsletters, I can assure you that there is never a lack of arguments on either side of any imaginable issue. It’s hard to keep an open mind in the face of this multitude of controversial arguments.
That is why the search for an additional index or historical analysis is often futile. The assumption of that search is to have a perfect approach or strategy, and it is our job to find it. But that assumption is false. And finding that assumption leading us to lose discipline can produce a good (but not perfect) strategy that benefits the long run.
Patience and discipline
It is important to choose an investment strategy with a good long-term performance and then go in thick and thin steps. It doesn’t always top out in sweepstakes in terms of performance, so you have to develop the discipline to stick with it through tough patches. Otherwise, you will be constantly guessing about your approach, which is the opposite of being patient and disciplined.
Think of it this way: Even if your never-ending mission actually discovers the “perfect” strategy, it won’t do any good to your long-term performance if you don’t. Follow it patiently and disciplined. In fact, you’ll probably make less money than a strategy that might not be perfect on paper, but stick to it.
Patience and discipline can turn a simple strategy into a winner, while a lack of those two qualities can turn a “perfect” strategy into a loser.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a fixed fee to be audited. He can be contacted at [email protected]