Five Ways to Break Free from Herd Decision Making
Tuesday, December 31, 2019
Now, information moves so fast that whatever insight you have, a million other people have had it, posted it, tweeted about it, and it's already affected the stock.
If we all make decisions in the same computational way, and we all use the same data that's instantly available to everyone, how can we gain an advantage relative to others—or to the market averages—in terms of our results? It's a real problem, of course, and has led many to take a purely passive approach—a mistake, in our opinion. The stock market is a tough game, especially when all the players are using the same inputs and processing those inputs in essentially the same way with the same brain tools. Here are some ways an investor can actually function as an individual decision-maker, and break free from the herd.
- Focus on goals or outcomes. If you're interested in long-term income from your investments, for example, you shouldn't be concerned about all the short-term noise from reports and commentary, but should be asking the simple question, "Is the dividend safe, and can it grow?" You'll then be investing for your actual individual needs, and not just chasing the rabbit everyone else is after.
- Learn from history. The typical investor's prediction addiction needs the therapy of history and probabilities for perspective. A true investment probability calculation is based on recognizing a similarity to historical fact patterns, as well as the risk/reward probabilities those fact patterns have shown in the past. As we know, past performance is no guarantee of future results, but, "In the past, during conditions similar to these, such and such was the likely outcome" is a more rational approach than, "I think…I believe…or it should."
- Adopt a longer view. Taking a longer view can neutralize the impact of information spread and speed. An infinite holding period would be ideal, and that can be a starting place, modified as time goes by when facts arise that truly stand in the way of the goals or potential outcomes established in #1 above.
- Dare to be skeptical. Skepticism is valuable. There is a tendency to herd around a thesis and believe what an analyst says, what corporate management says, what a pundit says. But these noisemakers may have conflicting agendas, whether it be kiting the stock, serving short sellers, or simply making a publishing deadline to say something. Ultimately one needs to find a company that one thinks will make progress in a "predicted" direction. But always do so skeptically, as high confidence is the enemy here. You may recall, for illustration, that a great number of pundits had high confidence going into 2019 that interest rates would rise during the year.
- Welcome surprise—and then diversify. Investment gains in the market depend just as much on surprise as on accurate prediction. If the markets are at all efficient, that must be true. If surprise were not a major element, someone would have all the money. We all realize the future is unknowable.
In hundreds of historical tests we and others have found that there are certain factors that, on their own or in combination with others, can result in excess performance. It would seem to follow, then, that an investor need only identify these factors and select the highest-ranking examples to create a passive portfolio. But it doesn't always work that way. The highest ranked are not necessarily the best performers, even when a group is. What explains this? The element of surprise. The antidote for this challenge is diversification—using a combination of quantitative and fundamental research to line up a population of investments where positive surprise is most likely.
It's entirely possible to build a portfolio of high-yielding stocks that are grounded in solid cash flow and free cash flow with durable prospects for the future based on stable end markets and proven management. We believe incorporating these five approaches can help you separate from the herd.
1 Barron's article, Master Stockpicker Peter Lynch: If You Only Invest in an Index, You'll Never Beat It, December 2019.
Lowell G. Miller founded Miller/Howard Investments in 1984. He began his studies of the securities markets as an undergraduate and has continuously pursued the notion of disciplined investment strategies since 1976. He is author of three acclaimed books on investing, including The Single Best Investment: Creating Wealth with Dividend Growth (Print Project, 2nd Edition, 2006). He has also written on financial topics for The New York Times Magazine, and has been a featured guest on Louis Rukeyser's Wall $treet Week and Bloomberg TV. Lowell is frequently quoted in financial media such as the Wall Street Journal, Dow Jones Newswires, Bloomberg, Fortune, and Barron's. He holds a BA in Philosophy from Sarah Lawrence College and a Juris Doctor degree from New York University School of Law.