How to avoid financial fishing lures

Charlie Munger has a knack for telling stories. One of my favourites is about the time the Berkshire Hathaway vice chairman was in Minnesota buying a fishing lure. He said to the shop owner ‘My god, it's pink and green, do fish really take these lures?' To which the old man replied, ‘Mister, I don't sell to fish'. 

The story is particularly relevant to the financial industry. Everywhere you look, someone is trying to sell you something. News and advice is specifically designed to excite investors and to keep them reading. ‘Click bait' as they say.

Stocks are either ‘skyrocketing' or ‘in freefall'. On a daily basis, we have to deal with the ‘[Whatever isn't running absolutely perfectly] crisis'. And, did you hear, ‘the company is expanding into China which has a population of a bazillion'.

Hyped language and gigantic claims sell newspapers but are rarely more than colourful fishing lures. When investing, however, it pays to remain calm. Exciting language often encourages risky behavior and steers you towards companies that have big potential, but where the odds of success are low – so called ‘lottery ticket' stocks. Speculative stocks should only ever make up a tiny fraction of your portfolio.

A short-term mindset is also subtly encouraged: ‘Biggest fall of year wipes nearly $27bn off Australian sharemarket'. The Australian does know that six months isn't a long time, right? And that, in percentage terms, we're talking about a decline of only 1.5%? Unnecessary fear promotes active trading, which clocks up brokerage fees and taxes that eat into your return.  

What's more, the financial news – particularly on TV –  is usually pitched as being ‘for serious investors only'. It's natural that we want to stay up-to-date with our investments, but you should watch out for information bias – our tendency to believe that the more information we acquire, the better our decision will be, even if the additional information is irrelevant. Reading and watching more news may not lead to better decisions, but it does encourage overconfidence.

Don't take the bait

So what should investors do? First, stay focused on the long term. If you're investing for the next 10 or 20 years, the most recent quarterly result and what happened in the news today probably doesn't matter. Feeling that you need to act on advice immediately is a big red flag. Impulsive buy and sell decisions are never a good idea, so sleep on it for a few days and build stock positions gradually.

Also, beware big claims. If someone offers you ‘risk free' returns in anything other than government bonds, hold onto your wallet. In fact, any promise for a particular return – be it 15%, 10% or even 5% – is a sign to keep moving. There are always risks so think carefully about the downside. As Warren Buffett put it, ‘When promised quick profits, respond with a quick no'.

Finally, news that emphasises a stock's price movement – rather than the company's financial and competitive position – is rarely worth your time, so stay focused on a company's fundamentals and think like a business owner. When investing, what matters is where the current share price stands relative to the company's intrinsic value. That's it. Everything else is probably just a lure.