We spend so much time talking about risk. There is another important concept that often gets overlooked. I want to introduce risk’s cousin, noise. It is especially topical with possibly the world’s most controversial person occupying the White House. I talk a lot about noise in my aptly-named book, Forget the Noise. Like in the book, I use this article to tell my story on noise.
Noise causes us to behave irrationally. It preys on our biases. The financial press is full of noise. Yes, the press. You can’t live with them but you can’t live without them. I will not be the first to highlight the damage the financial press causes. The Internet has certainly not helped matters. For all the good the Internet has done, it has been the worst thing for financial markets. Information (or rather “noise”) travels at the speed of light, intoxicating all exposed to it and convincing them to act. We like to think we are immune to market fads and speculation, but the reality is that we fall victim to them more frequently than we think.
Noise makes you do stupid things. It makes you sell investments at the worst possible times. Noise is also comforting. We are always looking to find the causes of events or the reason for something happening.
I can guarantee you that at some point in your life, you are going to see an investment drop at least 20% (probably more) from the price you paid for it. No matter what anyone says, this is a painful (but hopefully short-lived) experience. It is even more painful in magnitude than the corresponding amount of joy that we would experience if the investment doubled in value. Why is this the case? I put it down to my belief that we don’t like to lose and that we always expect to win – i.e. we believe that we make the best decisions. The academics call it loss aversion or prospect theory. Investopedia.com defines it as follows:
“A theory that people value gains and losses differently and, as such, will base decisions on perceived gains rather than perceived losses. Thus, if a person were given two equal choices, one expressed in terms of possible gains and the other in possible losses, people would choose the former.” *1
Why am I telling you this? You need to devise the fail-proof noise filter. I am going to give you a list of steps that I refer to every time I start to get that sick-in-my-stomach “I can’t believe this is happening” feeling. You may find my list useful as-is, or you may want to add to it. The point is that you need something to refer to and prompt you to start thinking rationally again.
I ask myself the following questions:
Is the sun going to rise tomorrow?
Is it still better to have monetary assets than returning to the barter system?
Are my investments’ earnings related to the level of prices in the world (e.g. inflation)?
Do I have a diverse number of income streams so that I am not dependent on any one income stream? (i.e. do I own numerous companies in different industries?)
Are some of my income streams from outside the country I live in? (protect against threat of wars or government confiscation)
If I can answer “Yes” to these five questions, then I carry on. No matter how many headlines I read about the dire state of the world and the unsustainability of this and that, I continue my investing strategy. You may argue that my list is too simple. This is intended. These are five questions I can ask myself quickly to check my state of mind. The worst thing I can do is make dramatic changes to my investment portfolio due to a noisy tweet. This list stops me doing so.
*1 URL: Prospect Theory Definition | Investopedia http://www.investopedia.com/terms/p/prospecttheory.asp [accessed August 2017]