Mohamed El-Erian on How to React to New Information

We have more information at our fingertips than ever before: company reports, news reports, blog posts, market updates, historical charts, and more. It can become overwhelming -- and even dangerous if you misinterpret the importance of data.

Two weeks ago I visited bond giant PIMCO's headquarters in Newport Beach, Calif. Its trading floor contains a staggering amount of information -- hundreds of monitors and TVs, each displaying row after row of new data and market prices.

I asked PIMCO CEO Mohamed El-Erian a simple question: With as much information as we have now, how does an investor separate the "signal from the noise"? Here's what he had to say (transcript follows):

Morgan Housel: We took a tour of PIMCO's trading floor this morning, which is quite impressive -- hundreds of screens, everyone has a Bloomberg terminal. I think it would be safe to say we have more information at our disposal that ever, not just for institutional investors, but individual investors -- Yahoo Finance, 10-Ks online. To borrow a phrase from Nate Silver, how do you separate the signal from the noise when we have this much information?

Mohamed El-Erian: So I love that phrase, because I wrote a book back in 2007 about the difference between when the system is providing noise and providing signal, so a few things are critical. First, your framework. So if you look, one of the screens out there are themes for the next few months, so it's really important to know what you are judging all this high-frequency information against. So putting out your priors and knowing what they are is very important, because either that information will confirm your priors or the information will lead you to revise your priors. But unless you know what these priors are, you're not going to be able to interpret the information. So that's the first critical issue.

The second critical issue is to have filtering process. So make sure that that information is filtered first and foremost by people who know what they're talking about. So we are divided into specialist groups, and the specialist groups are expected to filter that information, so to separate noise from signal, because there's a ton of noise that goes on.

The third element, which is the trickiest element, is differentiating between what's urgent and what's important. Human beings are great at dealing with the urgent important. OK, it's urgent, it's right there facing us, it's important, and we know what to do. We're pretty good, we're pretty good not falling hostage to the unimportant and not urgent. What makes an investment company great, as opposed to good, is what it does in these other two quadrants. A great investment company focuses on what's important, but not urgent. Just a good investment company focuses on ... what's urgent, but not important. So there's a real, real need to always ask yourself, beyond today, beyond this week, beyond next week, does this information have value? And that's why we supplement our cyclical short-term framework with a secular framework. So that people have a sense of what's important over time. And we work really hard at it. This stuff doesn't happen by chance. You have to have a structure, you have to have a tradition, and you have to enforce it, including creating a level playing field so that anybody feels entitled to say, "Hey, you know what? This is noise, not signals."

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