Beware of confirmation bias when investing

(Reprint of an original post written with my Anthrolytics co-author Elise Horent)

“What the human being is best at doing is interpreting all new information so that their prior conclusions remain intact.” - Warren Buffett

Image by Gerd Altmann from Pixabay

What is confirmation bias and why is it an issue? 

The process of decision-making can be long and tiresome, especially when it comes to decisions about money or perceived value. Therefore, we all tend to rely on mental shortcuts, known as heuristics – the rules of thumb we learn from experience or from others, or on our instincts. 

However, heuristics can lead us astray, as they may not be based wholly on facts or rational analysis; in this regard, they can form a cognitive bias where we think we are being logical and rational, but aren’t. 

One such cognitive bias is confirmation bias - the tendency for people to ignore information that contradicts their existing beliefs, in favour for any evidence that supports those beliefs. Also, we tend to find it is easier and quicker to process information we agree with, rather than to constantly challenge any opinion we already might have.  

A particular instance where this bias might be damaging is when thinking about investments we undertake. According to one survey of advisors, 93% of their clients are affected by confirmation bias and half significantly so:

Confirmation bias has become more of an issue in our everyday lives due to explosion of social media and the widespread availability of all types of advice and information (much of it misleading or not supported by facts). With the number and variety of these voices increasing in such an exponential way, it is understandable that most of us have developed a way to ‘triage’ this noise – tuning out what we think is irrelevant and focussing on what we wanted or expected to hear.

However, this also often leads us to seeking validation of our own opinions, instead of paying attention to contrary evidence. This can be especially problematic when it comes to deciding on investments. Even though no one wants to seek out bad investments, if we are already half-convinced that it is a good option, we’d be looking out for supporting information, rather than reasons why our investment might fail.  

Though, by seeking out and paying attention only to information that confirms our opinion, we can cause another issue: overconfidence. The more confident someone feels, the stronger their confirmation bias, leading to more potential mistakes – we want something to be true and it accords with what we already thought, so we act as if it is true, disregarding evidence to the contrary.  

There is also something of a generational effect; the same study also indicated that there is a difference in how vulnerable we might be to confirmation bias, depending upon our age. Generation X (associated with those born 1965-1980) seems to be the most affected, as they would’ve already been adults when internet use exploded, and would be less experienced with, or likely to be as critical of, online information than Baby boomers for example.  

So, the questions we now must ask ourselves is how do we know if we are making a good investment decision and what to do about it? 

Firstly, be aware of the risk of giving in to confirmation bias – try to pay as much attention to contrary evidence as supporting arguments.

Secondly, try to develop the critical thinking skills necessary to make better long-term decisions and recognise when confirmation bias may have affected our past decisions.

Finally, seek out impartial advice from banks and financial advisors, including looking through past and current decisions to remove potential for confirmation bias.