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Real News, Fake Understanding

The danger to investors of listening selectively.

Strange Thoughts

Behavioral researchers have cataloged dozens of ways in which people are predictably irrational. To begin with the ABCs, the "availability bias" explains why respondents expect unlikely events to repeat, the "bandwagon effect" describes how they favor opinions that have become more popular, and the "commitment bias" discusses why they cling so fiercely to their established views. (The remaining letters are also amply covered.)

Such quirks, of course, also apply to investment analysis. This column addresses two such tendencies: 1) the public’s interest in investment winners rather than losers; and 2) its attraction to bad economic news rather than to positive results.

Happy Talk

With individual securities, investors seek success stories. To be sure, habits can change. During the 1980s and 1990s, a host of investment magazines plastered "fund manager of the month" on their covers—a practice, one must confess, that Morningstar emulated, by publishing interviews and profiles. Such features have since disappeared. For one, most of those magazines have folded. For another, index funds have killed the mystique of the star mutual fund manager.

But the desire to hear about those who have won the investment lottery repeatedly resurfaces. Today, it appears in the form of meme stocks, cryptocurrencies, and nonfungible tokens. (Also gaining popularity have been online gaming and sports gambling, which satisfy similar impulses.) The impulse even found its way to an exchange-traded fund: ARK Innovation ETF ARKK.

While it's true that investment publications cater to this taste, it should also be acknowledged that when doing so, they follow their readers' wishes. For example, Morningstar has sometimes been criticized for awarding many more funds with its highest Morningstar Analyst Rating of Gold than with its lowest rating of Negative. That tendency exists for a reason. Morningstar's readers request research on funds that have performed well. Those that have not, they rarely investigate. By and large, the fund analyst who produces a Negative report writes to him or herself.

My columns receive similar responses. When I publish “best of” articles, they attract high traffic. When I write about what to avoid, those columns typically languish. Most readers are uninterested. They would like to know more about what they should buy, not what they should avoid.

Prophets of Doom

The opposite pattern occurs with broad investment issues. Consider, for example, pension plans. As this tweet states, over the past decade "thousands of op-eds" have bemoaned that pension plans were "living beyond [their] means." However, per the actuarial consulting firm Milliman, the funded ratio for the 100 largest corporate pension plans is now a comfortable 105%. Public pensions have fared less well, showing an average ratio of 85.5%, but that figure has nevertheless risen by 15 percentage points in recent years. The media's reaction? Silence.

It may well be that pension funds’ improvement is only temporary, buoyed by equity gains. Perhaps. But that precept applies in both directions. Just as today’s ratios owe in large part to the stock market’s recent performance, so did last decade’s figures. Yet only the unhappier outcome has been widely circulated. Few, if any, op-ed essays have celebrated the recovery of pension plans.

We can safely generalize this principle: When financial issues make the everyday headlines, they usually consist of troubles, such as rising inflation, soaring unemployment, or stock-market crashes. This resembles the approach of local newscasts, which subsist on fires, shootings, and lootings. With securities, investors wish to read about winners. With the broader economy, they prefer disasters.

Unintended Consequences

This barrage of negativity discourages stock-market participation. On the surface, the participation numbers are encouraging. Slightly more than half of American households own stocks, usually indirectly through mutual funds or ETFs. However, that percentage drops dramatically when 401(k) accounts are excluded. In addition, when the Federal Reserve Bank of St. Louis studied the subject three years ago, it found that over the previous 20 years stock ownership had gradually declined.

This condition does not affect the well-heeled, who thoroughly appreciate the power of compound interest and the merits of private enterprise. The damage instead has been inflicted on the rank-and-file. The wealthiest 10% of American households now control 89% of the retail stock market, as opposed to 77% in 2002. As equity returns have greatly outpaced wage growth, their investment gains have been the middle and lower classes' opportunity losses.

The corollary to skepticism is gambling. Those who believe in the U.S. economy will buy index funds (or other middle-of-the-road fare) and wait for good things to happen. That is an easy strategy to adopt, both in terms of investment selection and psychology. In contrast, those who constantly see disasters lurking around the corner are likely to speculate. For people with such beliefs, there’s no point in being like everybody else. To succeed, they must beat the averages. Such a task will likely lead to frustration—perhaps even to quitting investing entirely.

Personal Responsibility

While it's easy to blame the media for misleading the public by overemphasizing investment winners while blaring economic warnings, it's important to realize that almost all financial news is true. Financial reporters might be guilty of giving the people what they want, but they generally aren't guilty of inventing facts. The news itself is real, but its interpretation may well mislead.

At any rate, complaining about the media won't alter the reality. Newsmakers live by clicks, and those clicks come to stories that discuss hot investments and cold economics. Successful shareholders, I suggest, will reverse that formula. They will avoid the allure of investment lottery tickets while celebrating positive economic news. As Warren Buffett can attest, the best way to make money is by being a realistic optimist rather than an unrealistic pessimist.

John Rekenthaler ( has been researching the fund industry since 1988. He is now a columnist for and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.

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