Do Investment Results Suffer from Information Overload?

Last week, the CEO of British Petroleum, Tony Hayward, avoided answering questions from Congress, saying he could not provide answers because the investigation of the accident is still ongoing. Congress is looking for answers right now in order to formulate new legislation and was not happy with Hayward. Near the end of the hearing, Henry Waxman, D-Calif., told Hayward, “you’ve consistently ducked and evaded our questions and your evasions will make our job more difficult. … I think that is is regrettable and an unfortunate approach for you to take to the Congress of the United States.”

In this situation, Congress is looking for the best answers given the best information available now. In many ways, investing works the same way. Decisions often must be made on a timely basis, and overly exhaustive analysis or too much information can lead to sub-par results.

People who do horserace handicapping use historical data on horses and prior race results to estimate the odds for each race. In a classic study, professional handicappers were asked to predict various races. They were given increasingly more information about each horse and then, after studying these facts, were asked to predict its performance.

For the first round, they were given only five facts for each horse. For the second round, they were given ten facts. For the third round, twenty and finally in the fourth round, forty facts were given on which to make a judgment.

What do you think happened? After each round, the pro handicappers’ confidence level in their judgment increased. But their accuracy stayed the same! Once a minimum number of key facts are reached, adding more information does not increase the quality of the decision making. And in situations where time is of the essence (like the BP inquiry), gathering more question can decrease the quality of decisions because key actions are delayed.

I believe that most of the financial shows on the media provide investors with too much information. I watch many of these shows myself, but view this more as entertainment and rarely base investment decisions on them. Many of the guests are “talking their book” and may be providing biased information.

The bottom line is: Beyond a certain point, more information isn’t always helpful. For example, in large organizations, decisions made by large numbers of internal staff members and advisors often decreases the quality of the decision making. Excessive analysis often screens out promising new ideas that do not meet the standards of “traditional” financial benchmarks.

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