Signals and Noise

"We're not that much smarter than we used to be, even though we have much more information - and that means the real skill now is learning how to pick out the useful information from all this noise." - Nate Silver

Investing is hard. Investing?well?for a long period of time (decades, for example) is very hard. But investors often make it even harder than it has to be. With the amount of information available today from social media, television, and notifications on our cell phones, humans are constant consumers of data. And it’s easier to access information now more than ever. In the past you had to wait for the news to be published by newspaper or at least by the national media, today it is instantaneous. We can see this most easily by looking at companies like Google and Meta (Facebook) who generate billions of dollars in revenue each year from advertisers based on the amount of time us humans spend looking at our phones or the computer screen. Capturing our attention is big business these days, which makes separating the important (useful) information from the unimportant (useless) information very difficult. In fact, too much information can actually be harmful when it comes to decision making, contrary to how we often think about it. We assume that gathering as much information about a subject or scenario before making a decision could only be beneficial, as opposed to limiting our information to only the important points. Separating the signals (useful information) from the noise (useless information) is a valuable skill, and is often very important in investing.

Consider equity investing. In any given year (or month, or day) the price of a stock could bounce around dramatically, going from up 2% to down 6% to up 12% or more. What drives this volatility, or movement? It could be a news report that the company is laying off employees, or that geopolitical conflict has broken out between two countries thousands of miles away, or that the Federal Reserve Bank is going to raise interest rates again. These pieces of information may even come out all in the same day, and hardly are they ever optimistic. This is one of the issues with too much information, particularly “news” as it relates to investing. Most news is pessimistic in nature, due to its ability to attract attention relative to good news - if it bleeds, it leads. After all, pessimism comes off as if the person spewing it knows something others don’t and is trying to help, while optimism comes off as salesy and lackadaisical. To be a good investor, though, you must be optimistic. At the end of the day, investing is merely the belief that the future will be better than today.

So, how does one distinguish between signals and noise? I wish there were a magic formula in doing so, but there’s not. What can be very helpful, however, is decreasing the?frequency?of your data/news/information intake. The more a data point changes, or the higher the volatility, the less useful each data point likely becomes. For example, an investor with an equity portfolio and a 30-year time horizon is unlikely to benefit from analyzing the securities in their portfolio every day, closely monitoring the ups and downs hour-by-hour. We know that equities are historically more volatile than other assets, such as bonds, over the short-term, but have also provided significantly better returns over the long-term. Tracking the short-term volatility day-by-day will make most humans want to take action while the better strategy is often patience and?inaction. The signals, or useful information, in equity investing are more commonly the fundamentals of the company itself, such as earnings growth, competitive advantage and financial health, nearly none of which change day-to-day or month-by-month.

So, instead of focusing on every piece of news, data, or event that is reported daily, try to focus on the short-list of things that are most important to long-term investing, such as discipline, patience, and optimism.

Disclaimer:?Trust and Investment Management Services are not a deposit, not FDIC insured, nor insured by any federal government agency, not guaranteed by the bank or its affiliates, and may lose value. This general market commentary is intended for informational purposes only and should not be considered investment, financial, or legal advice.?