How Media Excess Can Mess With Your Wealth

John Woerth, a spokesman for the Vanguard fund family, says he measures the hysteria of the media by the number of talking heads appearing at any one time on CNBC. At 2:40 p.m. on August 8, with the stock market sinking fast, the dreaded "octo-head" materialized. Woerth reacted by sending out a wry e-mail suggesting that it was time to sell stocks and buy Spam and bottled water.

Meanwhile, he reports, relatively few Vanguard customers sold stocks or stock funds, and those who did sell were roughly matched by those who bought (Vanguard is the largest mutual fund company by assets; see Vanguard’s Fad-Free, Low-Fee Approach for more on the fund juggernaut). This occurred on a day when some commentators were saying that investors were “running for the hills” and “cashing out.”

The disconnect between reality and the Chicken Little pronouncements of the financial media is often profound. Your first reaction to these sorts of divergences may be to say, so what? The problem is that by playing on investors’ psychological biases, the media can influence our behavior in a way that can be harmful to our wealth.

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Take, for example, the notion that investors are rushing to cash. That may be true for many institutions and traders, both professional and amateur. But when it comes to individual investors, the vast majority sit tight during financial crises. Reporting to the contrary, however, can trigger the herd-mentality bias. We’re wired to think that there’s safety in numbers, and so we are tempted to follow the herd. Worse, it has been proved that actions of the herd can actually change the way we perceive a problem, bending our thinking to the herd’s point of view.

Many investors also tend to rely on third-party experts during periods of uncertainty, a phenomenon known as social proofing, says hedge-fund manager Lauren Templeton. But all those supposed experts pontificating throughout the day simply reflect the current state of emotions, says Templeton, who teaches a course in behavioral finance. “Successful investing relies on rational decision-making, which in many instances requires delayed gratification,” she says.

Our biases become exaggerated during times of uncertainty, says Alok Kumar, finance professor at the University of Miami. One important bias, he says, is loss aversion, or the sometimes irrational pain we feel at losing money -- which can goad us to sell just to avoid further pain. Losses hurt more if you’re watching the news continuously and taking the trip down with a falling index. If you’re invested for the long term, “it’s best to ignore the news,” he says.

And rapid-fire reporting often lacks perspective, which can lead to excessive focus on what’s happened lately, known as recency bias. Vanguard strategist Francis Kinniry says it’s important to weed out the noise, especially during a crisis, and focus just on the important things that might really lead to change. He reminds us that the U.S. economy is the world’s largest by a wide margin, and that the market value of all U.S. stocks is 45% of the world’s value. “Everyone’s in love with China and India, but their markets are about the size of Apple’s market value,” he says.

Bottom line: If you’re a long-term investor and don’t want your financial biases messing with your head and undermining your portfolio, don’t drink too long from the financial media’s fire hose.