Friday, July 10, 2009

Why Investors Do What They Do: The Effect of the Media Hype on Investors

Has the hype in the media over the last several months had an effect on how you invest in your retirement plan? The answer is most likely, yes. And the reason is the media presentation of investor news and nowhere is this done better than on television.

Thomas Schuster, who wrote the book "The Markets and The Media" suggests that television news has changed the way investor's react and eventually what they do. "Novices," he writes, "receive their basic training in investment issues via the media, even via such an improbable candidate as television."

Because the news is interested in only short-term events, Mr. Schuster worries that that sort of focus "provides explanations which afterwards evokes an impression of logic". There is unfortunately no way for even a savvy investor to parse that sort of information, see a developing trend that encompasses both the past and the recently reported story and make any sort of logical decision. But people do.

And the reason for this is pure coincidence. Sometimes your perception and the reality of what is happening meet and when they do, there is often a seismic shift in not only how you view your investment strategy but fundamental values as well.

There is no rational for this type of behavior short of we just do it. We treat stock information garnered from television, even stations devoted to the interactions of business and their shareholders/investors as if it were information worth having. There has been some speculation that the real traders understand this and seek to profit from this sort of non-knowledge.

It is as they say, much easier to swim with the tide. And many traders are now focused on doing just that, predicting when their colleagues, other investors all begin to believe something is worth more than they know it should be worth. The benefit these traders have is knowing that they are investing on emotion and because of their cold-hearted approach to the subject, bail long before the rest of the group realize what it is that they don't know.

So what do we do? The best thing would be to cancel cable and turn off the television. But that isn't going to happen. So the following three suggestions might help.

First: examine why you did what you did in the first place - you know, before you began to question those motives. Chances are you were probably right. If you used your retirement plan according to the time-honor, take-a-lot-of-risk-when-you-are-young method of investing, you probably should go back to that. That is, if you have changed. The most recent news has sent folks scurrying for the less risky forms of investments in their portfolio largely in part because of how the news portrayed the stock market's reaction the global financial crisis.

If you did, keep in mind that "the crisis" affected everyone, equally it seems. The second thing to remember is that you are not the only one with a damaged portfolio. If you managed to keep your job, weren't too deeply in debt and for all intents and purposes, are saving more, your approach to retirement should not have changed. Although the economy (even the global one) will not recover evenly, it will in fact recover with time. If you had spread your risk across four or five sectors (growth - large, mid-cap, small-cap, international and emerging markets) you would have covered all of your bases and be on the way to a decent recovery.

Third thing to remember is that this will take awhile. If you do not feel as though you have enough time I have bad news: investments take time and worse, take their own sweet time returning to normal. But as renowned economist and thinker John Kenneth Galbraith once suggested, the market has no memory. But you will often recall the pain of a loss much more vividly than the market does and this will keep you from making the correct investment decision when you are most emotional, which is often in the aftermath of some new piece of news.

If you have a short horizon, you need to either lengthen it or reevaluate what your plan intends to do for you if you do not allow it to recover before you start drawing down the assets.

Next up: The negative effects of optimism.

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