Don't Let Today's News Drive Your Investing
Any investor not upset by the paralysis in Washington probably doesn't have a pulse. Both sides seem far more interested in scoring political points than in resolving the current crisis.
See Also: The 7 Deadly Sins of Investing
I don't know how this will end, though I'm fairly optimistic that we'll avoid breaching the debt ceiling — if for no other reason than that the consequences would be so horrible and long-lasting. But I don't know for sure, and I'm not willing to bet a penny either way on the outcome.
What I do know is that you would do well to pay little attention to the news — not just during the current government shutdown and debt-ceiling standoff, but all news events — when making investment decisions. It seems counter-intuitive, but investing based on the news is one of the worst mistakes an individual investor can make.
Here are four reasons why:
1. The market moves ahead of the news.
No bell went off on March 9, 2009, to mark the end of the biggest stock market selloff since the Great Depression. Indeed, the worst recession since the 1930s continued to deepen into the summer.
Stocks typically move about six months ahead of the economy. How can that be? The stock market reflects the current wisdom, knowledge and hunches of all its investors. Academic studies have consistently shown that the collective opinions of market participants are usually remarkably accurate. That's why it's so hard to beat the market, and why index funds beat most actively managed funds.
That's also why the Conference Board's index of leading economic indicators prominently includes the recent returns for Standard & Poor's 500-stock index as one of its predictors of where the economy is headed next. By the time you read dire — or upbeat — news, it's too late to buy or sell. The news is already reflected in stock prices.
2. You're not in the loop.
Corporate executives and other insiders usually know a lot more about how their business is doing than you can ever hope to know. Savvy fund managers and good stock analysts do, too.
In the case of the impasse in Washington, the major brokerage houses and institutional investors, including big mutual fund firms, contract with ex-journalists, former congressional staffers and former office holders to try to keep ahead of the curve on political developments.
Individual investors don't have anything but the Internet. This is a game to leave to the professionals.
3. There's too much media hype.
You know how the weatherman is always predicting that an approaching storm could trigger tornados? It keeps you tuned in. The same thing, of course, happens with news stories.
As a longtime journalist, I know how hard mainstream reporters try to tell each story honestly. But I also know how much pressure there is — with the rise of the Internet — to publish pieces that get tons of hits from Web surfers. That often means a minor disagreement between two politicians ends up characterized as a major brouhaha. And even mild economic weakness winds up portrayed as a dangerous crisis.
4. You can't time the market.
Jumping in and out of the market based on the news requires incredible luck to succeed. You might get it right once or twice, but I know very few who have done it consistently enough to beat a simple buy-and-hold strategy. And those few who have succeeded don't do it based on the news; they use far more sophisticated techniques.
To time the market you have to make two decisions well: when to buy and when to sell. A handful of economists and strategists told investors to sell in mid 2007. But most of them were subsequently years late in turning bullish, missing a gargantuan market run-up.
A Better Way to Invest
What should you do instead of investing based on the news? I'd start by building a diversified portfolio. Even the youngest investors need some bonds, and even the oldest need some stocks. And you should own U.S. stocks and foreign stocks, as well as large and small companies.
But you should tilt your portfolio toward the best values. Right now, stocks look more attractive than bonds, given the puny yields that bonds offer. Similarly, if you consider price-earnings ratios, large-company stocks are cheaper, relative to history, than small-company stocks. Foreign-company stocks boast lower P/Es than U.S. stocks, and emerging-markets stocks are the cheapest of them all.
I know, I know. There are plenty of good reasons why foreign stocks are cheap and emerging-markets stocks are even cheaper. But reversion to the mean — the tendency of prices and returns to move back to their long-term averages — is a powerful force in the markets. You often just have to be patient enough to let it work its magic. And this is an advantage you have over the pros. You can afford to wait; they're under pressure to put up good numbers every quarter.
So diversify, and overweight what's on sale. By contrast, investing based on the news is about as effective as chasing your tail.
Steven T. Goldberg is an investment adviser in the Washington, D.C., area.