You've all heard them -- the daily market commentaries that try to make every day seem like the most important day in history. On a day when the market falls, you might hear, "Stocks went for a roller coaster ride today as stocks initially rose on news of progress in negotiations with Iran, only to plummet as rising oil prices and the North Korean threat shot fear onto the trading floor." If the market rises, then you could just flip the sentence around. Sensational stories sell media advertising.
Stop to consider this for a moment. Did the market really rise or fall solely because of some single top news item?
While some major events may indeed have a substantial impact on the financial markets, the idea that one could explain the workings of a mechanism as complex as the market with a single cause is ludicrous. Although it may seem comforting to some that market fluctuations could all have simple explanations, the fact is that no one will ever know all the reasons behind a market's movements on a particular day.
The media roller coaster
As long as mainstream media sources attract an audience, however, you can be sure that the ride will continue. It's easy to turn on the television to a financial news channel or to pick an Internet website with continuous quotes and watch the zigs and zags of thousands of different indices, stocks, futures, and other types of investments. You can even use those sites to enter your own holdings and identify at any minute of the trading day what your portfolio is worth.
Like a real roller coaster, this constant coverage can provide a great deal of entertainment. If you enjoy watching or reading up-to-the-minute coverage of every single thing that could possibly have even the smallest effect on some financial market, then there's nothing wrong with that. The key, however, is that you have to be able to treat it as exactly that: entertainment.
That's hard for most people. After all, investing isn't just a fun ride at an amusement park. Your life savings are at stake. If you hear someone on your television telling you that the next stock market crash is right around the corner, it takes a great deal of discipline to stick with your investments -- especially if they have already gone down. Just like on a roller coaster, if you panic in the middle of the ride, you may well want to get out of the action just to feel like you're on stable ground again.
Now, on a real roller coaster, you can't stop the ride, and the metal bar keeps you locked in your seat until the ride is over. The problem with the financial markets is that you're in charge of your investments, and there's no metal bar keeping you in your seat. If you panic, you can completely change the composition of your portfolio in a matter of seconds. With the touch of a mouse button or a telephone call to an automated service, you can often make as many transactions as you wish without having to talk to a single human being.
The consequences of stopping the ride
Just as trying to get off a real roller coaster in the middle of the ride is obviously dangerous, trying to change your investments dramatically in the middle of a volatile period in the financial markets creates substantial risk. Acting on instinct, you lack a plan for what you will do after you enter those panicked trades. If you choose another risky investment, say a current high-flier like Hansen Natural (NASDAQ:HANS) or NutriSystem (NASDAQ:NTRI), you may well find that your efforts were for naught as the new investment falls just like the old one did. If you stay in safe investments like cash money market funds, you may well miss out on a rebound in the market, while inflation and taxes whittle your return to nearly nothing. By the time you get your feet back underneath you, it may be too late to get back to your original plan without giving up a significant amount of potential return.
Even if your gut instinct turns out to be correct for a time, it's hard to decide when to get back on board. There is a strong temptation just to stay away from your original investments entirely. After all, if they have already fallen, they could easily fall more. Realizing that they could also easily recover and even rise to new peaks is extremely difficult, especially since market declines usually amplify the noise of the mainstream financial media as it spreads into everyday conversations.
Closing your eyes
On a roller coaster, if you couldn't stand looking at the big dive that was coming up ahead, you could always just close your eyes, scream, and wait for the ride to be over. Similarly, if you have a sound financial plan, it doesn't hurt to close your eyes and tune out television, the Internet, and newspaper financial news. Although information in general is valuable, too much information can make you act irrationally, and you may be better off with less information. If, instead of looking at your portfolio several times a day, you only look once a month, your portfolio will still experience the same change in value, but your perception of it will be much less choppy.
One of the best examples of this was in 1987, when the stock markets rose strongly during the first half of the year and then fell precipitously in the fall, culminating in late October in the largest short-term drops since 1929. Listening to the then-nascent financial media, it seemed as if the world was ending. One could easily imagine selling everything no matter what. If you had done that, you would have sold at the absolute bottom and potentially missed out on more than a decade of strong gains. On the other hand, if you kept your eyes shut during the year and looked only at your statements at the end of 1986 and the end of 1987, you would have seen only that you had earned a small positive return.
The financial media can be highly entertaining. In making important decisions about your money, however, you may prefer to keep your eyes closed.
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Fool contributor Dan Caplinger welcomes your feedback. He doesn't own shares in any of the companies mentioned in the article.
