Good decisions require good data, but too much could backfire
What do you need to make a good decision? Are you comfortable with making choices in the absence of all the information? Every day, investors make decisions based on what they know, what they think they know, what they don’t know, and what they don’t know they don’t know. Decisions with future outcomes are, by definition, uncertain. The ultimate accuracy or rewards of those decisions is not correlated with our comfort level when making them. We can have a great deal of conviction about something that has a terrible outcome.
More information provides increased comfort, but the evidence proves it does not enhance our decision-making ability. A recent Wall Street Journal article highlights research indicating that, “When it comes to actually making decisions with data, oftentimes, ‘less is more’.” The research provides examples of when this would be the case, including choosing among job applicants and college admissions.
We have quote on our website by Herbert Simon. It says, “A wealth of information creates a poverty of attention.” Our minds have trouble processing too much information at once, especially when there is conflicting data, as is often the case. The best way to overcome this is to identify the pieces of information needed to make an informed decision and rely on that. Do not veer from the guidelines you set out.
Additional bits of information trick us into thinking we are better informed. We gain a false sense of confidence even though additional information does not provide incremental benefit and may actually be detracting from the relevant data. There is a diminishing return to incremental pieces of information after a point. Determining that point is more useful than gathering any and all information.
In the book The Art of Thinking Clearly, Rolf Dobelli has a chapter called Less is More. It is about the paradox of choice. He says, “a broader selection of choices leads to poorer decisions.” When faced with many options, we tend to rely on something familiar or that “feels good” even though it might not be the best criteria to use. He further explains that too many choices often leads to post decision regret. When there are many alternatives, there is more opportunity to second-guess ourselves.
The paradox of choice refers to deciding between multiple choices, instead of using many pieces of information to make one choice, but the lesson is the same. In investing, there are thousands of stocks, ETFs, mutual funds, bonds, and other available assets to choose from. Then, there is the task of evaluating each one with a growing mountain of data, some relevant, most not.
If being data-driven and well-informed is the goal, rely on this data point: less is more.