In 1986, economist Fisher Black published an influential paper about a concept that he called “noise”. He described it as the opposite of information, which provides evidence to back up a certain claim, while noise does not.
In the economy, noise takes many forms including inaccurate data and analysis, as well as hype and trends.
Black believed that many people made decisions based on noise, rather than information, and this had the potential to seriously harm their investment returns.
The good news is, there are ways to identify noise and separate it from information, so you can make more measured decisions that align with your financial plan.
Read on to learn more about noise in financial planning and how you can avoid it.
Understanding the different types of noise
There are two main types of noise that could affect you: external and internal noise.
External noise
External noise refers to outside factors that could influence your decisions, such as news stories about the latest investment trends or global events that affect inflation, for example.
In 2023, you’ve probably heard a lot of noise about market volatility caused by global events like the Covid-19 pandemic or the war in Ukraine. It’s likely that you have also seen stories about rising interest rates on cash savings.
This could lead you to believe that it is safer to take money out of investments and hold your wealth in a cash savings account instead.
However, the Office for National Statistics (ONS) reports that inflation was 6.7% in the 12 months to August 2023.
In comparison, the best rate on an easy access savings account on 7 September 2023 was 5%, MoneyFacts reports. As such, your cash savings may lose value in real terms if you make decisions based on noise about external factors, rather than reliable information about inflation and interest rates.
Internal noise
Internal noise refers to the way that your past experiences and existing beliefs affect your decisions. This kind of noise often manifests as cognitive biases that cause you to process information in an illogical way.
“Confirmation bias” is one of the most common cognitive biases, causing you to discount information that goes against your existing beliefs. For example, when researching an investment, you may focus on the potential gains and disregard any information about the risks because you already believe it to be a good investment.
“Loss aversion” is another bias that can affect your financial decisions. It is the theory that we feel the pain of loss more acutely than the pleasure of gains.
As a result, you may make panicked decisions to sell an investment when its value drops temporarily. Yet, if you held the investment and focused on your long-term strategy, it could well recover and deliver gains in the future.
There are countless different cognitive biases that influence the way you make decisions about your financial plan. Being aware of when this is happening could make it easier to avoid noise.
Noise could be costing you 2% of your returns each year
Both types of noise can overwhelm useful information and cloud your judgment, ultimately leading to poor decisions about your wealth. As such, it is important that you can identify noise and discount it as much as possible.
Unfortunately, more people listen to noise during times of uncertainty as they are more prone to panic.
Indeed, according to FTAdviser, emotion-led decisions could be costing investors 2% of their annual returns. Additionally, 47% of financial advisers say that their clients’ biggest investment mistake is being too influenced by the news.
Fortunately, there are some simple ways to identify noise so you can discount it and remain focused on your own financial plan.
3 questions to help you separate noise from information
Trying to distinguish noise from information can be a challenge. Yet, if you consider these three questions, you may be able to identify and discount noise when making decisions.
1. Is it hypothetical?
Hypothetical noise is incredibly common, and it often comes in the form of “expert” predictions.
By their very nature, any predictions about the future are hypothetical and usually based on assumptions.
You may assume, for example, that a certain stock will increase in value because there is a lot of buzz about the company. However, this is likely based on external noise such as news stories about the business or recommendations from other investors.
Internal noise may also influence you if you have found success investing in the same sector in the past, for example. As such, these predictions are usually noise, not information.
Historical data about the long-term performance of the stock market, on the other hand, is not hypothetical.
So, while past performance does not guarantee future returns, this is still useful information that supports the benefits of a long-term investment strategy.
2. Is it distracting?
Much of the noise that you hear sounds alarming, but ultimately has nothing to do with your own financial plan. It is simply a distraction.
News stories about current events are a prime example of this. While these events may cause short-term market fluctuations, they are not likely to affect your long-term investment strategy.
For example, in the last 20 years, we have seen several significant market disruptions caused by the 2008 financial crisis, a global pandemic, and the war in Ukraine.
If you had adopted a short-term investment strategy, these fluctuations could have affected you.
However, if you plan to hold investments for the long term, they could well recover from these losses and continue growing. As such, you could still achieve your life goals.
Consequently, you should always consider whether the information will have a tangible effect on your financial goals. If it doesn’t, it is noise.
3. Where does it come from?
The source of any information you hear is also very important, especially online. Social media, for example, is filled with unregulated users with no credentials offering opinions and predictions about your finances.
Additionally, there are many people operating investment scams and targeting users through social media. So, it is important to research the source and consider the viability of any information you read before acting on it.
You also need to consider the motivation behind any assumptions and decisions you make. Are they based on cognitive biases, or reasoned decision-making?
If you can’t trust the source of the information, you may want to discount it as noise.
How to avoid noise in financial planning
Focus on your own goals
A good financial plan is based on clear goals about the lifestyle you want now and in retirement.
Typically, noise is not relevant to these goals, especially investment advice that you find online or warnings about market volatility.
By focusing on your goals, you can remind yourself that your current strategy is tailored to you. As such, you don’t need to make any changes, provided you are still working towards your long-term aims.
Ultimately, this makes it easier to remain calm and shut out noise, instead of reacting to it and deviating from your financial plan.
Take a long-term approach
A lot of the distracting noise you hear encourages short-term decision-making. Warnings about global events causing market disruption, for example, may encourage you to sell investments to avoid losses.
However, history has shown that markets typically bounce back. So, short-term movements might not necessarily affect your long-term goals, as your investments could recover in value.
As such, try to shut out any noise about short-term fluctuations and focus on the long-term performance of your investments instead.
Work with a financial planner
Working with a financial planner can help you avoid noise in several ways. Firstly, they can help you create clear goals to focus on, which makes it far easier to ignore outside influences.
Additionally, they may be able to help you do due diligence before making investments and explain what the effect of any changes to your financial plan might be.
Consequently, your decisions are more likely to be based on information about your own financial plan, rather than being influenced by unhelpful noise from others.
Finally, they can offer support and reassurance during periods of market volatility, so you may be less prone to panic.
Get in touch
If you find it difficult to discern noise from useful information, we are here to help.
Please give us a call on 01276 855717 or email info@braywealth.com today.
Please note
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
The value of investments and any income from them can fall as well as rise and you may not get back the original amount invested.
Past performance is not a guide to future performance and should not be relied upon.
Approved by The Openwork Partnership on 15/09/2023.
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