The sharp market decline in January has raised the anxiety level of investors everywhere and brought out the worst in the financial media. Many investors are asking the wrong questions, like these:
1. Is this the beginning of a market correction?
2. Should I sell my stocks and just "sit on the sidelines"?
3. Is this a buying opportunity?
The peril of predictions
It's not surprising that CNBC is leading the charge in setting the tone for irresponsible journalism. Fear, greed and uncertainty are a tried-and-true formula for increasing viewership. More viewers mean more revenue. More revenue makes the securities industry happy. And the securities industry, in turn, is the primary source of revenue for the financial media.
You can learn a lot from an article published by CNBC more than a year ago, on Jan. 31, 2014. The title of the article, "January's Decline Sparks Stock Correction Concerns," is illustrative of the problem.
January 2014 was similar to January 2015. The market sharply dropped in both months. In each case, CNBC trotted out "leading market watchers" who made predictions about the significance of the market decline for the balance of the year.
JPMorgan Chase's chief U.S. equity strategist, Tom Lee, didn't believe a 10-percent correction was likely last year. He predicted the S&P 500 index was going to end "at least at 2,075." He was pretty close. The S&P 500 closed on Dec. 31, 2014, at 2,058.
James Paulson, the chief investment strategist at Wells Capital Management, predicted the S&P would rise "toward 2,000 sometime [in 2014], before correcting back towards the 1,850 level by year-end."
Rick Bensignor, a "strategist" at Wells Fargo Securities, disagreed. He crunched the historical numbers on stocks and warned the market could see a painful 15-percent correction. Don't worry, Rick. There's always next year, and most investors won't remember your faulty prediction anyway.
CNBC noted the adage "As goes January, so goes the year." The "January barometer" has apparently been right in 62 of the last 85 years, or 73 percent of the time. I'm sure many investors relied on the "January barometer" last year and exited stocks, to their great detriment.
Why predictions are useless
Consider the track record of economists making predictions the next time you watch a pundit on CNBC muse about the future of the market. As indicated in this blog post by my colleague, Larry Swedroe:
1. Since 1990, economists have forecasted a year in advance only two of the 60 recessions that occurred around the world.
2. The majority of economists didn't predict the three most recent recessions (1990, 2001, 2007) even after they had begun.
If economists with advanced degrees and training in assessing economic data have such a dismal track record, don't you feel foolish relying on Jim Cramer, Art Cashin and "leading market watchers" who claim to have the ability to make accurate predictions?
Genetic biases
It's bad enough that much of the information in the financial media is calculated to lead you astray and enrich your "market-beating" broker or advisor. But there's compelling evidence that bad investor behavior is not attributable solely to bad information. A recent study found that genetic differences help explain why so many investors engage in poor investor behavior.
The authors of the study used data from the world's largest twin registry, the Swedish Twins Registry. They examined data on the investment behavior of identical twins (who share 100 percent of their genes) and fraternal twins (who on average share only 50 percent of their genes). The authors surmised that if identical twins exhibited more similarity with respect to investment biases than fraternal twins, it would demonstrate that these behaviors are influenced, in part, by genetic factors.
They found that, for many investment biases, genetic differences explained up to 45 percent of the remaining variation across individual investors, after controlling for observable individual characteristics. They concluded that persistent investment biases are "to a significant extent determined by genetic endowments."
They also found that among investors with work experience in finance, the role played by genetics was less. In contrast, general education did not reduce the importance of genetic factors in explaining investment biases.
The finding of this study is that, while your individual experience explains most of your investment decisions, inherited genetics may also play an important role. Think about that conclusion when you are inclined to not diversify, select stocks based on a "home-country bias," chase returns or engage in excessive trading.
The takeaway
As you confront your anxiety in dealing with a volatile market, here are some principles that should help guide your investment decisions:
1. Ignore short-term data. It's meaningless and has no predictive value.
2. Ignore the mainstream financial media and everyone who claims an ability to predict the future of the markets or "explain" what is going on in the markets.
3. Be aware that your genetic makeup may play a role in preventing you from making intelligent investment decisions.
4. Be guided instead by the basic principles of "evidence-based investing." Is your financial future worth an investment of $0.99 and about an hour of your time? If so, you should read (and reread) If You Can: How Millennials Can Get Rich Slowly by William Bernstein. This mini-book is only 48 pages and is packed with investing wisdom. If you follow Bernstein's investment advice, your expected returns will be higher than the majority of individual and institutional investors who engage in stock picking, market timing and attempts to select the next "hot" fund manager.
Dan Solin is the director of investor advocacy for the BAM ALLIANCE and a wealth adviser with Buckingham. He is a New York Times best-selling author of the Smartest series of books. His latest book is The Smartest Sales Book You'll Ever Read.
The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.