Confirmation bias is a very important concept – especially for investors. It is the tendency you and I have to look for proof that we are right rather than look for the truth even if that means we are wrong. Along the same lines, that same bias leads us to downplay information if it is counter to what we already believe is right.
On the face of it, this may seem like a pretty natural thing to do. The problem is that because we are confirmation biased, we tend to ignore competing truths that might help us make smarter investment decisions.
Here’s an example outside the financial realm. Let’s say you happen to be a libertarian. You’re going to read what other libertarians write. You will talk to other libertarians and listen to other libertarians as much as you can. This is fine except that once in a while a conservative or liberal person might have a better idea you hadn’t considered. This shuts you off from the potential to learn and grow and maybe take a different (better) course of action. This concept is at work of course no matter what your political views are.
If this phenomenon only related to politics it would be bad enough but confirmation bias also extends to how we invest. And if you want to make smarter investments, it’s crucial that you isolate that problem a.s.a.p.
Let’s say you are convinced that the price of gold is going to the moon this year. If you allow that opinion to influence your research, you’ll ignore any contrary opinion or facts and gather as much support for your notion as possible. That could be a very expensive error.
What happens to people under the spell of confirmation bias is that they don’t see when the tide has changed. They are so stuck with their own beliefs that there is basically nothing you could show them or say to them to help them get a balanced view.
How expensive could this problem be?
I met a man a few years ago who was convinced that the government was going to take his 401k and nationalize all retirement accounts. I have no idea where that stroke of genius came from but he was absolutely convinced this would be our fate. What did he do?
Despite all the proof I laid at his feet to the contrary, the man took all his money out of his retirement accounts to keep it “safe” . Meanwhile he incurred a huge income tax penalty as a result of this move and lost the ability to take advantage of continued tax deferral for the many years ahead.
Are you suffering from confirmation bias?
Of course I can’t tell you but I can share a study done by the American Psychological Association a few years ago. They concluded that people look for information that confirms what they already believe to be true twice as much as they look for information contrary to what they already to believe to be true. In other words, it’s highly likely that you and everyone you know suffer from this problem.
How do we overcome this problem?
What can you do to get out from under this problem? Two things:
1. Handle the truth.
Admit that this phenomenon is real and examine your own behavior. Make sure that when you do your research, you aren’t just looking for facts that support your existing opinion.
2. Get out of your comfort zone.
Go out of your way to look for opposing views. Actively try to find some value and truth in ideas you generally disregard. Ask yourself, “what if I’m wrong?” “What would someone with a different opinion think about this?” “What would they say?” And if all else fails, talk to your investment mentor.
If you want to make sure you are making smart investments please look for the opposing view and thoroughly consider the opposite opinion. Are you confirmation biased? What has it cost you? What are going to do to overcome this?