How to Escape the Trap of Knowing Too Much

Editor's note: Our world is moving faster than ever. Each day, investors must face a flood of information... everything from new technologies to the Federal Reserve's next move. In this piece – which we last shared in DailyWealth in April 2017 – our colleague Dr. David "Doc" Eifrig outlines why you don't need to know everything to make good investments. Instead, all you need are a few key details to help you ride the wave...

It sounds crazy, but you can know too much about a stock.

This is hard for people to accept in our "Knowledge Is Power" society... where the Internet puts thousands of pages of information, data, and news about a company in front of us with a few clicks of a mouse.

People like to believe that with enough information, they can make a perfect decision... that by adding fact after fact, data point upon data point, their understanding becomes increasingly clear. But it doesn't always work like that.

In the field of behavioral finance – which looks at how people make decisions about money – studies have repeatedly shown that humans usually gather too much information... and sometimes get stuck in the process.

Picking a stock, bond, or fund isn't an exact science. Often, it means letting some facts and data go.

Don't misunderstand. I'm not saying you should dive into the market half-cocked, throwing money at every hunch and tip that comes along. (And if you saw the blizzard of magazine clippings and journal pages spilling from my desk, you'd be tempted to call me a hypocrite.)

You do need to understand the companies you buy.

But don't spend so much time collecting data that you fall into the trap of knowing too much and then forgetting to take action...

People can easily be paralyzed by indecision. At a certain point, investors can get lost in a sea of ratios and statistics that don't add to their understanding of the investment.

For example, you could have a stock that looks expensive based on the past 12 months of earnings (and which just missed earnings by $0.02 in yesterday's earnings announcement), but still looks like a steal based on "consensus Wall Street estimates of future 12-month earnings." What are those conflicting signals telling us? Which are important? What can we ignore?

Honestly, what does something like the debt-to-equity ratio tell you that net tangible assets growing over three years doesn't tell you? Is that distinction vital to buying the stock? Heck no.

Don't get bogged down in old data...

I follow the work of an English clergyman named Reverend Thomas Bayes to guide my investing strategies. In a paper published in 1764, the reverend and mathematician outlined a method of assessing probabilities, now called Bayesian statistics... In the simplest terms, it represents commonsense investing.

Bayes believed it was important to build in your past experiences while looking at data – creating what he called "priors." That way, you can create a probability of something happening in the future. It turns out, the human brain does this well... as long as it doesn't get emotionally attached to the earlier decisions. For investing, this is critical to understanding.

Modern-day author Malcolm Gladwell wrote about this ability in his book Blink: The Power of Thinking Without Thinking, which I highly recommend.

When I analyze stocks, I stick with a time-tested and simple strategy...

First, I seek out companies with long histories of growing or stable sales. If a company has endured lean years in the past and has come out strong, it can probably do it again in the future.

We want to see healthy cash flows because they tell us the company is making cold, hard cash... not just using accounting tricks in its earnings reports (like Enron).

Finally, we want to see a clear pattern of rewarding shareholders with dividends and stock buybacks. Dividends compounded over time are the most consistent path to big returns.

I've told subscribers many times that "dividends don't lie." Companies can't fake a cash payment like they can manipulate other items on the balance sheet. If you're going to write a dividend check, you have to have the cash to cover it. And a rising dividend is like a magnet drawing shares higher.

Just remember that when you buy or sell something, do it based on the facts of the past plus your experience. Then combine those into expectations (probabilities) for the future.

And avoid anchoring your current decision to a past decision. Cut your losses early if the trade isn't going your way. Don't stick with it just because you bought the stock.

With these steps, you can focus on the information that matters most. Once you learn to recognize what's important and what isn't... it's time to act.

Here's to our health, wealth, and a great retirement,

Dr. David Eifrig

Editor's note: The headlines – and the markets – are buzzing over one big breakthrough today... the rise of artificial intelligence ("AI"). What does this emerging technology mean for your money? Is it a dangerous fad, or is it here to stay?

The implications are dizzying. That's why Doc is teaming up with Marc Chaikin – and a special guest – to separate fact from fiction. You see, AI just broke one of the fundamental laws of technological theory. And because of it, this story could reshape the investing landscape in 2023 faster than most folks believe.

If you want to learn more, make sure you join us on Wednesday night for this free online event. Find out how to tune in right here.

Further Reading

"The 'information bias' is the tendency to value and incorporate information – even when it's useless," Doc writes. This problem doesn't just keep investors from buying. It can also cause folks to sell at the wrong times... Learn more here.

Legendary investor Warren Buffett used to focus entirely on one idea – buying value. But eventually, even Buffett changed his tune. Value matters, but it isn't everything, especially when everyone has reams of information at their fingertips... Read more here.