The Financial Media Hypothesis (FMH)

Last Updated Jan 1, 2010 6:24 PM EST

It's always intrigued me as to why the financial media seems to focus on what is behind us rather than in front of us. Ever the masters of predicting the past, they will predict more good times when times are good, and more doom and gloom when times are bad. I've arrived at a theory for this irrational behavior that I'd like to call the Financial Media Hypothesis (FMH). The FMH states:

FMH: Successful financial media must predict a continuation of the past.

Example of Media Hype
I've called out best-selling author Harry Dent more than once on this, and I'm going to do it again because he offers the best example of this FMH hype. During the bull market years of 2004 - 2006, and with claims of using all sorts of "proprietary independent economic research" to back it up, Dent predicted the Dow would reach 40,000. After the crash of 2008, Dent shifted his prediction sails toward the great depression ahead, and the Dow plummeting to 3,800.

The point of this example is not to show that Dent has been consistently wrong, but rather to offer a great example of predicting the continuation of the past. It perfectly illustrates the two forces driving the FMH: recency and confirmation bias.

Recency bias
Human beings hate randomness. We like to feel we are in control. Thus, we like to find patterns. Many studies, however, show that we overweight recent events and discount events that occurred years earlier. This bias is known as recency bias. With this bias, combined with fear and greed, we tend to chase performance and consistently buy high and sell low.

Recency bias partially explains why so many investors felt fearless in 2007 and put so much in stocks, only to panic and sell after the 2008 plunge. Those of us in the media are also human, with the same tendency toward predicting the past. Sure, we use all sorts of so called sophisticated analysis to support our conclusions, but it still comes down to letting recent events dominate our forecasts.

Confirmation bias
For years, I thought recency bias was the total driver of why the media predicts the past. Then, when interviewing Jason Zwieg, author of The Intelligent Investor column for The Wall Street Journal, he handed me the second piece of this hypothesis - confirmation bias.

Confirmation bias is the human trait of looking for information that supports our decisions, and avoiding information that seems to contradict it. If, for example, you believe emerging market countries will have the best stock market returns, you are more likely to read articles that support this conclusion, rather than ones that give data showing the fastest growing economies have not turned in the strongest stock market performances.

Combining the biases
Recency bias contributes to buying investments after they have gone up and selling after they plunge. But after we have made these buy high and sell low decisions, it's confirmation bias that causes us to seek out media that support our decisions. Thus, we want to read that more good times are ahead after we have bought stocks, and that gloom and doom is ahead if we have sold. Any articles to the contrary are far less likely to get read.

I'm happy to say that the FMH doesn't explain everything. There are writers out there, like Jason Zweig, who are successful and yet willing to share their wisdom by writing to warn us against our destructive behavioral traits in investing, as Zweig has done in The Little Book of Safe Money.

To avoid the effects of the FMH giving us what we want rather than what we need, I suggest you write down your core beliefs on investing. Then seek out any articles that take a contrary view. It may not be fun, but it may help you protect your finances.

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    Allan S. Roth is the founder of Wealth Logic, an hourly based financial planning and investment advisory firm that advises clients with portfolios ranging from $10,000 to over $50 million. The author of How a Second Grader Beats Wall Street, Roth teaches investments and behavioral finance at the University of Denver and is a frequent speaker. He is required by law to note that his columns are not meant as specific investment advice, since any advice of that sort would need to take into account such things as each reader's willingness and need to take risk. His columns will specifically avoid the foolishness of predicting the next hot stock or what the stock market will do next month.

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