Just about every bad idea when it comes to investments starts with the premise of acting on special information “the market” as a whole doesn’t recognize. “I heard about (fill in the blank) in the news and I’m really worried about it.” Or “I’m thinking about investing in XYZ company because of (fill in the blank). What do you think I should do?” The answer to these questions is almost always some variation of “you should do nothing.” The reason is simple – by the time you know a piece of information it has already been incorporated into market prices!
The Market Incorporates All Available Information Instantly
You’ve probably heard people say that markets are “efficient” at incorporating information – but what do they mean by that? This short video from Dimensional Fund Advisors helps explain how markets instantly incorporate all available information about a company or investment through the buying and selling of investors:
The Big Event
In this age of hyper-connectivity, the millions of investors across the world (many who trade full time) pick up on new information and trade based upon that information rapidly. That creates a stock market that moves up or down quickly to reflect any new information that comes out. If good news comes out, market prices go up to reflect that. If bad news comes out, market prices go down to reflect that. By the time you hear about something, markets have already reacted to it and it’s too late to do anything about it. Remember how quickly international markets dropped during “Brexit”?* Nearly anyone who tried to sell out of stocks in response to that was too late and sold after the market had already declined. That’s like piling sandbags after a flood – it doesn’t do you much good.
The Hot Stock
I was talking to the passenger next to me on a plane a couple days ago and when he heard I was a financial advisor he took that as an opening to tell me all about the stock picking he does. He works in artificial intelligence and thus was very focused on a handful of tech stocks because he knew all about how fast they were growing and changing the industry as we know it. I said this is no doubt the case, but what information do you know that the millions of informed investors buying and selling in the market do not? The stock market not only instantly includes all available information about a company, but also investors’ expectations about future prospects. What information or expectations about the stock do you have that aren’t already incorporated into the price of the stock today?
Think You Should Act On Your “Special” Information? Don’t.
Next time you are tempted to change your investment portfolio based on something you heard on the news or read in a financial journal, ask yourself the following question, “Am I the only one who knows this?” The answer is most likely no, and you probably should leave your portfolio as it is.
*Past performance is not an indicator of future results.