“Framed” Financial Performance News: What You Can Do About It

How information is presented—or “framed,” in behavioral finance terminology —influences our perceptions. Whether you hear a market summary on the radio as you commute home, watch it on the nightly news, or read it on screen or in the paper, the financial media often frames the performance in disorienting ways. Jim Parker, Vice President, DFA Australia Limited, proposes three reorientation’s in his essay,“Future Testing.”

Download (PDF, 240KB)

Look to the future, not the past.

Invariably the media frames days of sharp declines as bad, when in fact such days may be good investment opportunities. Parker notes that the “media could just as easily say, ‘Stocks went on sale today, as falling prices offered investors higher expected returns.’ If you are a long-term investor, the key issue is how your portfolio performs from now on, not what happened yesterday.”

Consider your goals.

The financial media reports market performance with a focus on the short term, and based on the assumption that all investors have the same future, the same goals. In this investment scenario, a sharp decline in the market is always bad news. In actuality, whether a market decline is good or bad depends on your goals. Warren Buffett frames drives the point home in his clear, homespun manner:

If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.

But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices. – 1997 letter to Berkshire Hathaway shareholders

Focus on what you can control.

In our intensely competitive financial markets, where new information surfaces and is assimilated like plankton entering a whale, gaining an edge is difficult. Instead of trying to time the market or find the mispriced security, Parker recommends you focus on what you can control: (1) fees and taxes, (2) broad diversification, (3) exposure to “dimensions of expected return,” and (4) risk management derived from sticking to a carefully considered target allocation mix. By “dimensions of expected return,” he means risk factors which help explain long-term performance. DFA, Jim’s employer, structures their funds to gain exposure to these risk factors which provide compensation and vary depending upon whether one is looking at stocks or bonds.

Stock Risk Factors

• Market (the total stock market provides higher expected returns than risk-free one month US Treasury bills)
• Size (small companies provide higher expected returns than large companies)
• Relative price (“value” companies with poor prospects or financially stressed provide higher expected returns than growth companies with bright prospects or financially healthy)
• Expected profitability (companies with persistent high profitability provide higher expected returns after screening for size and relative price)

Bond Risk Factors

• Term (bonds with longer maturities have higher expected returns than short maturities)
• Default (bonds with low credit ratings have higher expected returns than those with high credit ratings)

It is hard not react to the media’s often-negative framing, so Jim’s healthy reminders on alternative choices are very helpful.

This blog entry is distributed for educational purposes and should not be considered investment, financial, or tax advice. Investment decisions should be based on your personal financial situation. Statements of future expectations, estimates or projections, and other forward-looking statements are based on available information believed to be reliable, but the accuracy of such information cannot be guaranteed. These statements are based on assumptions that may involve known and unknown risks and uncertainties. Past performance is not indicative of future results and no representation is made that the stated results will be replicated. Indexes are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Copyright © 2014, Granite Hill Capital Management, LLC.Links to third-party websites are provided as a convenience and do not imply an affiliation, endorsement, approval, verification or monitoring by Granite Hill Capital Management, LLC of any information contained therein. The terms, conditions and privacy policy of linked third-party sites may differ from those of this website.