Mutual Fund Investors: Beware Of "Information Overload"

If you're like the vast majority of investors around the world, you're most likely a victim of the information overload syndrome. It might surprise you to know that this pernicious little tendency to constantly seek out information, often from different sources - and often altogether conflicting - could prevent you from reaping rewards from your portfolio in the long run.

This behavioural bias finds its roots in the mistaken belief that when it comes to information, "more is better". The masters of investing would beg to differ. Warren Buffet, for one, is not one to focus overtly on the next quarters earnings or descend into vast pools of data and information before deciding to buy or sell a stock. "Our method is very simple. We just try to buy businesses with good-to-superb underlying economics run by honest and able people and buy them at sensible prices. That's all I'm trying to do.", he once famously said when quizzed about his "investment technique".

There's something really interesting about information and its significance when it comes to decision making, though. Paul Slovic, in his paper titled ""Behavioural Problems of Adhering to a Decision Policy", used racehorses and bookies to arrive at the conclusion that beyond a certain threshold, incremental information on a given subject (such as investing, for instance) does not improve accuracy of decision making - which is to say, accuracy flatlines at a point, despite adding on new information. However, confidence continues to increase with every new piece of information added. In other words, more information may not necessarily lead to more accuracy in your investment decision making - but it will most likely make you more confident!

What makes the matter more interesting is that when it comes to computing, more information indeed does appear to be better - a separate study by Tsai, Kalyman and Hastie titled "Effect of Amount of Information on judgment accuracy and confidence" proved that the predictive accuracy of a computing model increased from 56% to 71% when new information about predictive outcomes related to college football games was introduced. When the same information was presented to human evaluators, accuracy did not increase with the increase in information!

The tendency to seek out mountains of information before making investment decisions is accompanied by another interesting behavioural bias known as the "confirmatory bias" (read my article on the confirmatory bias here: http://businessworld.in/article/Before-You-Invest-Prove-Yourself-Wrong-/06-02-2017-112493/). While scouring the internet and other sources for information, we have the human tendency to seek out information that fits in with our own worldview! For instance, if you're firmly bullish on the markets right now, you're more likely to seek out information that confirms your point of view, while remaining blindsided to other information that may be pointing you in the wrong direction. How can that be fruitful?  

There's an important lesson in all this for Mutual Fund investors, especially novice ones. One, don't get so caught up in your own worldview (bullish/bearish) that you remain oblivious to information that could be suggesting a different course from what you have in mind. Two, do not attempt to consult every single Advisor in a five-mile radius and their uncles, in the mistaken hope that this will yield you more information, resulting in a better investment decision. Three, limit the data points that you look at online before selecting a fund. Truthfully, this is all the data you need in order to make a go/no go decision about a particular Mutual Fund:

1.    Fund Manager Pedigree and Track Record
2.    Fund Philosophy and level of adherence to the same (true to label or not)
3.    Fund Vintage (at least five years is preferable, ten is better)
4.    Performance in nonconductive market conditions (such as rising yield scenarios for debt funds or bearish phases for equity funds)
5.    Worst Quarter/ Best Quarter performances
6.    An assessment of the fund's risks - and whether that level of volatility is acceptable to you per your risk profile

Checking off the six points detailed above will arm you adequately to make a sound investment decision. Try not to get into the nuances of timing the market to capture a single days NAV movement, or whether the top 10 holdings are great or not. Remember, Mutual Funds are meant to be "hands off" investment avenues. It's best to pick good funds based on minimal but critical information points, and let the Fund Managers do the rest.