Distinguishing the Signal from the Noise
WHEN IT COMES TO INVESTING, WE SEEM TO BE ADDICTED TO INFORMATION. The whole investment industry is obsessed with learning more and more about less and less, until we know absolutely everything about nothing. Rarely, if ever, do we stop to consider how much information we actually need to know in order to make a decision. As Daniel J. Boorstin opined, “The greatest obstacle to discovery is not ignorance—it is the illusion of knowledge.”
The idea that more information must be better seems obvious. After all, if the information is of no use, then it can simply be ignored. However, psychological studies cast doubt on the soundness of this seemingly innocuous belief.
Is More Better?
In one study,25 eight experienced bookmakers were shown a list of 88 variables found on a typical past performance chart of a racehorse (e.g., the weight to be carried, the number of races won, the performance in different conditions, and so on). Each bookmaker was then asked to rank the pieces of information by importance.
Having done this, the bookmakers were then given data for 45 past races and asked to rank the top five horses in each race.
Each bookmaker was given the past data in increments of the 5, 10, 20, and 40 variables he had selected as most important. Hence each bookmaker predicted the outcome of each race four times—once for each of the information sets. For each prediction the bookmakers were asked to give ...