Noise, according to Nobel-prize winning economist Daniel Kahneman, is the unwanted variability that can cloud judgment and impact decision making. We can make different decisions when influenced by noise, such as when we are upset, tired or hungry compared to calm, rested or well-fed. Kahneman shows how doctors give drastically different diagnoses to identical patients as a result of this noise. Most of the time, we are unaware of the noise and neglect it. Yet, by reducing it we can make better decisions.1
Nowhere is the impact of noise more evident than in investing. Modern behavioural economists have shown that noise can significantly change the way we make investing decisions.
In the excitement of rising markets, there has been a particular amount of noise to distract investors. Strong markets give confidence to some investors to take on greater risks. We are also living in a period of technological change and new innovation can make it difficult to assess risks, as expectations are largely driven by hope and uncertainty about the future.
In May, the cryptocurrency Dogecoin, a joke named after a “doge meme,”2 became the fourth most valuable digital currency after gaining over 14,000 percent to start the year. This was a surprise to its cofounder, who reportedly created it in “a few hours” and sold his holdings in 2015.3 Similarly, SPAC issuances have surged, prompting regulators to warn investors not to be “lured into participating in a risky investment.”4 SPACs sell shares with the objective of buying a private company and taking it public. They are known as “blank cheque” companies for a reason: they have no operating business and often no stated acquisition targets.
As investors, we must cut through the short-term noise as we invest for the longer term. It’s easy to get caught up in the excitement — we’d all like to ride the next superstar investment to financial freedom. We may also feel that we aren’t successful investors unless we are in the middle of the action. Yet, when there is too much enthusiasm for what appears to be a good thing, it can prove unsustainable — the warning signs sometimes only apparent to the astute.
What is the opposite of noise? According to Kahneman, it is discipline. Some of the most successful investors are able to ignore the noise when they make portfolio decisions. They follow the specific rules established to control risk within a portfolio. While such an approach may not produce the results that make overnight headlines, it provides a good litmus test to avoid being carried away by the enthusiasm of the moment. In a world of noise, discipline can be one of the investor’s greatest assets.
Today’s investing landscape looks particularly different than one year ago: Some global economies have reopened and we have seen strengthening commodities prices and increasing inflationary pressures. The changing times are precisely when trusted advisors can provide thoughtful evaluation and scrutiny in investment choices, shifting gears where necessary to position for change.
Let’s enjoy the market advances, but don’t be led astray by the noise. Maintain discipline and continue to look forward — and use my/our resources to help you achieve your investment goals.
- Kahneman, Sibony, Sunstein (2021),Noise: A Flaw in Human Judgment. Harper Collins; 2. Meme: an amusing captioned picture/video widely spread online through social media; en.wikipedia.org/wiki/Doge_(meme); 3. markets.businessinsider.com/currencies/news/dogecoin-price-rally-eclipses-xrp-4th-largest-crypto-doge-2021-5-1030391242; 4. Special Purpose Acquisition Company; sec.gov/oiea/investor-alerts-and-bulletins/celebrity-involvement-spacs-investor-alert