Research suggest that more data leads to overconfidence, which has long been associated with investor underperformance.Torsten Asmus/Getty Images/iStockphoto
You might think that access to more data than ever should make us better investors. Well, new data says no.
When I first started investing, the freshest data available was in the back of the newspaper business section where daily mutual fund unit prices were published. For the previous day’s close. Today, the real-time bid and ask prices for every publicly listed security in the world is accessible from my phone.
But while the accessibility and sheer volume of data available to investors has grown since the 90s, my desire to look at it has decreased. A study published last year in the academic journal Management Science suggests I’m on the right track to get better returns.
Back in 2017, Yahoo Finance terminated a free service that provided access to raw stock market data to anyone who wanted it. Until that point, many people used this data service to inform their trading.
But after the data was cut off, instead of getting worse returns, the researchers found that these investors got better at making trading decisions. The active traders had less information to analyze but this led to a lower volume of higher-quality trades.
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This flies in the face of the idea that more data always leads to better decisions, at least as it relates to investing. As usual, it comes down to the investors’ worst enemy: ourselves. The authors of the research suggest that more data leads to more overconfidence, which has long been associated with investor underperformance.
Specifically, the authors detail three illusions that investors with access to high volumes of data can fall prey to. The first is the illusion of knowledge. Just as some casino slot machine players swear to “have a system,” many stock traders can convince themselves they have identified a pattern in stock movements that they can capitalize on. This is rarely the case.
The second is the illusion of precision. Active traders with access to more data may believe their analyses are more predictive of the future because they analyze more variables. Personally, I see it as more chances to be wrong, but that’s probably also why my trading activity is not too different from that of a dead person.
Third is the illusion of control. One feature of greater access to extreme volumes of data is the ability to pick and choose what data points to analyze. This may fool investors into thinking they have more control over their investment outcomes.
But the paradox of more access to data being associated with lower performance is not limited to active stock picking. I’ve often found that the most financially successful individuals I’ve ever met put more of an emphasis on behaviour than data analysis.
It’s less about rates of return than it is about rates of saving. Some people thrive by setting detailed budgets coupled with hypervigilant monitoring, but a simplified budget framework of “paying yourself first,” coupled with avoiding going into the red with what’s left over, is remarkably effective too.
If we look at our world around us, we are bombarded by more alerts, nudges, and notifications than ever. In some cases it turns into information overload, which translates into financial paralysis.
One of the most oft-repeated phrases in investing is to “tune out the noise.” One way to do that is to have predetermined playbook in the form of a financial plan complete with an investment policy statement. That way, you don’t have to concern yourself with the firehose of short-term data which might induce you into making short-term, reactionary choices.
Instead of looking at a thousand small levers we can pull, we’d be much better off focusing on a few big levers.
Preet Banerjee is a consultant to the wealth management industry with a focus on commercial applications of behavioural finance research.