The Importance of Ignoring Market Noise

The market is a volatile place, and so it's easy to think in the short term. Don't let that happen, stay discipline with your investing goals.

Warren Buffett famously said that like dieting, successful investing is far easier to understand than to accomplish—because it requires discipline. Perhaps nowhere is investing discipline more important than regarding the never-ending din of market information blaring at investors through various media outlets.

Long a problem for investors trying to maintain focus, this market noise has become appreciably louder for most consumers since the internet has become widely available.

Since then, there has been not only nonstop television coverage of financial markets on CNBC (and, more recently, Bloomberg), but also from a myriad of websites that investors can visit at 3 a.m., worrying about daily market gyrations instead of sleeping.

So that they don’t miss anything, investors often volunteer to be bothered by market noise regularly by signing up for email alerts. And as if this weren’t enough, purveyors of this market noise have exploited the public obsession with mobile phones by distributing apps and issuing text alerts making sure investors can’t escape market noise by leaving the house. Now, they can hear this din wherever they can find cell service.

The reason this noise is dangerous is that it compels short-term thinking and over-reaction that can wreak havoc with long-term portfolio gains. Market volatility is a fact of investing—and not a bad thing in and of itself; it enables investors to buy stocks at lower prices.

Investing through volatility

John Bogle, credited with inventing the index fund, said the question isn’t whether your investments will go up and down in value, because this will inevitably happen. Rather, he said, the question is whether this volatility will bother you enough to make you over-react and do “something dumb.”

If you over-react to volatility, this increases the chances that you’ll sell low, only to buy high when you want to get back in later, after prices rise. As Buffett has pointed out, volatility and risk are two different things.

Focusing on price alone isn’t really investing. Rather, it’s speculating. Whereas, investing is about seeking value. Obsession with short-term market movements makes sense for traders who make a living by accumulating small gains and seeking to limit losses on as many stocks as possible. They don’t care about long-term trends, but the average investor managing a retirement portfolio definitely should.

Trading on volatility doesn’t improve long-term returns. One way to get a sense of this is to look at the volatility of the S&P 500 index and U.S. bond yields. Over one-year horizons, these two measures vary greatly. However, over long periods—15, 20, 30 years--the averages of the two are much closer.

This shows that reacting to short-term price movements carries no advantages over the long term. Even if the entire market is tanking, it’s important to remember that it has always bounced back, often quite soon. Many recent dips have popped back up in the ensuing days or weeks, and the average recovery time from most steep declines has been a matter of months.

Furthermore, trading too much has high costs, including taxes on gains. If you’re in a high tax bracket and you jump in and out of stocks regularly from listening to market noise, you’ll be triggering ordinary income tax on gains—as much as 35 percent. By contrast, if you trade occasionally rather than regularly, after owning stocks for at least a year, the long-term capital gains rate (15 to 20 percent) applies.

Long-term thinking

All this reactive trading racks up high trading costs, including commissions and advisory fees. Frequent trading tends to increase costs incurred by the bid-ask spread, the trading process that determines the price buyers pay.

Instead of listening to and trading on short-term market noise, investors are better off ignoring it and focusing on the long-term, mustering the discipline to stay true to their plans, to reach their long-term goals.

Rather than heeding market noise, long-term investors would be much better off paying attention to:

• Maintaining a well-diversified portfolio with investments selected for value, rebalancing portfolios regularly and practicing dollar cost averaging—buying fixed dollar amounts of stock regularly to garner more shares when prices are down.
• Minimizing fees and taxes to contain costs and increase net returns.
• Doing regular cash-flow analyses to assess gains against goals and determine whether you’re on track with your investment plan.

This is a far better course than trading on market noise (which compels trading by others, in turn making gains harder to get).

Many declines, as well as upsurges, are driven by computer algorithms designed to trade automatically in response to certain price movements. Many of these programs sell automatically when the average price of a stock has declined by 10 percent. This trading is so massive it depresses prices. Much of the noise you hear about volatility stems from this type of institutional trading.

So, instead of listening to market noise and haplessly trading like a scared rat caught in a maze and bombarded by stimuli, put your phone down, relax, and keep your eyes on the prize: your long-term portfolio.

Related Articles

• Keep Calm When the Stock Market Plunges It Can Create Opportunity
• Incorrectly Thinking the End Has Arrived

David Robinson, a Certified Financial Planner, is founder/CEO of RTS Private Wealth Management, an SEC-registered firm in Phoenix that provides fiduciary services to help clients achieve their financial goals. His practice focuses on helping wealthy individuals with custom financial plans, using a holistic approach to grow/protect wealth, manage taxes, identify insurance solutions, prepare for retirement and manage estate plans.