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Financial Happenings Blog
Sunday, March 23 2008

The financial media is a beast that we all need to be careful in applying to our investment decisions.  In any given newspaper, magazine or website there is a good chance that there will be a range of interpretations of the current market activity and forecasts about what is going to happen in the future.  These types of stories help financial media "sell" their story to actively minded investors seeking hints as to their next big investment decision.  However we forget that the basic instinct of the financial press is to sell the advertising space that surrounds their coverage.  Do they actually believe in what they are writing?  Are they investing their own money in light of their own commentary?  Your guess is as good as mine.


What we do know is that we need to keep the intentions of the financial media in mind and take care in how we interpret their commentary.  Our approach is to look to the analysis that focuses on the fundamentals of how investment markets work rather than sources trying to provide "guesswork" and crystal ball forecasts.


An article published in Saturday's Sydney Morning Herald written by Annette Sampson highlights what we see as a fundamental of investment markets - behavioural finance.  Behavioural finance is the study of the behaviours of investors and why they invest in the manner in which they do.  Annette's article, 'Investors behaving badly are to blame for this market mayhem', looks at the phenomenon of investors trying to pick market turning points.


She leads with the famous quote from Kenneth Gailbraith:


"We have two classes of forecasters: those who don't know . and those who don't know they don't know."


The article suggests that even though it is futile to try to pick the top of bull markets and the bottom of bear markets, the nature of humans (our hard wiring) makes us overconfident


"overconfidence leads us to believe we have much more control over our investments than we do, and it makes us emotionally invested and less able to cope when those brilliant profits start to evaporate. We take the losses personally and believe we should have been able to prevent them."


The article hints that the few examples where forecasters get it right, this skill is not shown to be repeated in the future suggesting the correct prediction was purely a matter of luck.


The conclusion of the article is that investors should focus on the long-term and take a big picture viewpoint.  This takes out the more emotional short term decision making.  A final quote from the article sums the story up in a nutshell:


"Behavioural finance says we're more inclined to react emotionally than rationally when making investment decisions. We're hardwired to hate losing money, assume the past is a guide to the future, and think we're more in control than we are. There will always be people who think they can time the market, but the odds are that they, too, will get it wrong."

Posted by: Scott Keefer AT 08:53 am   |  Permalink   |  Email
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