Sep 21, 2009|
Investing: How much information is enough?
Information is vital to all decision making. Since investing essentially boils down to decision making, it is a topic of great importance for investors. With the advent of the electronic age, especially the internet, there has been an information explosion. In fact, it would not be an exaggeration to say that each day computers generate more information than that contained in all the libraries in the world. There is also no dearth of information related to finance and investing. In this article we shall examine whether more information is inherently better than less information when it comes to investing.
"The greatest obstacle to discovery is not ignorance - it is the illusion of knowledge." - Daniel J. Boorstin, American historian.
When the traditional view holds that more information is always good, it does not account for the fact that human beings are not supercomputers. While the human brain is a marvelous organ and is capable of some unique achievements, it is constrained on both counts - discarding redundant information and processing voluminous information. In fact, that is at the core of why we resort to heuristics or mental shortcuts in the face of an information overload.
Hazards of information
Several studies have been conducted on participants like medical professionals, bookies, MBA students and laypersons. They have shown that given our human frailties, information beyond a certain level leads to the following peculiar results:
- Overconfidence bias: Increasing information does not increase accuracy of our judgment, but it strongly increases the confidence we have on our judgment.
- Confirmation bias: We form conclusions from the initial information and subconsciously seek confirmation from the subsequent information that flows in. As a result, extra information hardly leads to any new conclusions.
How to deal with information
- Be selective: Instead of being bewildered by the torrent of information, pick the most relevant data points from the most reliable sources. When it comes to investing, reading the financial reports of companies is a must. After all, even Warren Buffett spends hours every day reading the 10Ks (annual filings) and 10Qs (quarterly filings) of companies and their competitors. He's been doing this for half a century now!
- Stress on application: It is not how much information you have. Beyond a certain point, it is what you do with the information that truly matters. Hence, investors should make an attempt to analyze basic information over the years and across competitors rather than chasing fancy facts. Do something with the information. It is well known that investors like Warren Buffett, and before him Benjamin Graham, can assemble basic information in very intuitive and insightful fashion. It is not by chance that Buffett's analysis, in his letters and articles, are so readable, it is by design. Investors should attempt to apply basic data with simplicity and clarity to develop a logic or narrative. It may be noted that Buffett's partner Charlie Munger also stresses the importance of reading high quality business periodicals and applying fundamental theories to explain events.
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