Have you ever noticed a big slowdown on the interstate and wondered what it was that was holding up traffic ahead, only to arrive at the cause of the delay to find a beautiful view of a sun setting over a farmers pond that was so majestic everyone had to slow down for a longer look? Or maybe a family playing fetch with their golden retriever on the front lawn? Maybe a couple of horses galloping blissfully across a field?
Of course not. Why would anyone slow down to view something peaceful, serene, or just plain normal?
For some reason, as humans, we are drawn to chaos and catastrophe. The source of that long delay was almost certainly a multi-car accident, a house on fire, or an arrest in progress. These are the types of things that captivate our attention and cause us to hit the brakes and take a longer look.
So, what in the world does this have to do with investing? A lot, actually. One of the greatest risks to us as investors is what we call "Headline Risk", and it can cause us to make very poor decisions.
Media outlets (newspapers, websites, news channels) know what types of headlines capture and hold our attention most effectively. They know why we slow down on the interstate. They know what makes us look up from our coffee. They know what makes us click that link on our Facebook feed. Chaos, catastrophe, fear. Media outlets are paid based on viewership, subscribers, clicks, etc. They're going to pump out whatever most effectively captures our attention.
Is it starting to make sense why we see so much doom and gloom every night on the news? Anyway, let's narrow the focus so I can make my point....
One of the areas that we feel the most pain and carry the most fear is in our pocket book. We pay very close attention to what's going on with the economy because it affects that pocket book, especially by way of our investments. When you combine that already heightened sensitivity with a media industry that's incentivized to publish scary headlines, you get Headline Risk. While there are several variations of it's definition and impact, I would define headline risk as: the risk of making poor financial decisions as a nervous reaction to scary stories put out by the media.
Let me give you some examples of headlines over the years that very likely caused a lot of folks to make poor long term investment decisions:
Fear of a Double Dip Recession Could Cause One New York Times-May 15, 2010
Dow plummets 634 points amid downgrade backlash CBS News-Aug 8, 2011
The Fiscal Cliff and America's Coming Recession Forbes-Nov 9, 2012
Government Shuts Down in Budget Impasse New York Times-Oct 1, 2013
World markets plunge as China stocks crash CNNMoney-Aug 24, 2015
Stock Turmoil: Dow Plummets More Than 1000 Points at Open NBC News Aug 24, 2015
These are just a tiny fraction of the headlines we saw from 2010 - 2015. Just based on the headlines, you'd think markets must have been awful during those 5 years, right? Investors must have gotten crushed!
Actually, from 2010 to 2015, the S&P 500 returned an annualized average of almost 13% and more than doubled over that period!
Now, how many folks do you imagine sold out of that market or never invested in that market because of the headlines they were seeing all over their newspapers and televisions? I imagine a lot. This is one of the major reasons that individual investors fare so much worse than the stock market overall. According to a study of investor behavior and results updated annually by Dalbar, from 1986-2016 the S&P 500 has averaged about 10% annually, however the average investor only averaged about 4% during that same period of time.1 Could it be that headline risk is preventing us from participating in the gains in the stock market?
It goes a little something like this: We feel some pain from a market pullback, we read some headlines about things surely collapsing, we sell off our investments to avoid impending doom, and then we sit on the sideline while the market finds it's footing and rallies higher. We sold low, now we have to buy back high. When we buy back in, the market is at new records and goes through a normal correction. The media pumps out a bunch of scary headlines again, we get nervous and sell again just before the market finds it's bottom and rallies much higher. Wash, rinse, repeat.
Now, Headline Risk can also work in the opposite direction. Sometimes the headlines can lead us to believe things are better than they are. Take a look at some of these headlines from the years leading up to the Great Recession of 2007-09 where the stock market fell by about half. Keep in mind this crash was triggered in large part by the housing market and subprime mortgages:
Experts see no housing bubble San Francisco Chronicle-Feb 12, 2005
Home prices posted solid gains in 2005 CNNMoney.com -Feb 17, 2006
Bernanke: Subprime Woes Won't Seriously Hurt Economy CNBC-May 18, 2007
Finally! Dow finishes above 14000 CNNMoney.com-Jul 19, 2007
We all know what happened after that....But again, if you're making investment decisions based on headlines, you were probably digging through the couch looking for spare change to throw in the stock market. According to the news, the stock markets hitting records, the housing industry is booming, the chairman of the Federal Reserve is telling us not to worry...
The point here is this: Don't change your investment strategy based on what you're seeing on your TV, hearing on your radio, or reading in your newspaper. These outlets get it wrong just as often as they get it right. Work with an advisor to get a long-term strategy in place based on YOUR needs, YOUR time horizon, and YOUR tolerance for risk. Don't change that strategy just based on headlines. As I showed you above, headline risk can lead you very astray and cost you a lot of money.
P.S. : Here is a fear mongering headline from earlier this week, November 12th, 2018 warning of a 66% market crash....Ignore the noise, folks.
‘Trap door under the market’ could slash S&P by two-thirds, warns fund manager' - Marketwatch.com
This is meant for educational purposes only. It should not be considered investment advice, nor does it constitute a recommendation to take a particular course of action. Please consult with a financial professional regarding your personal situation prior to making any financial related decisions. Indexes are unmanaged and cannot be directly invested into. Past performance is no guarantee of future results. Investing involves risk, including the potential for loss of principal.