R.P. Seawright of Above the Market recently released his list of “Investors’ 10 Most Common Behavioral Biases,” valuable juxtaposition of most common investing mistakes with the behaviors and attitudes behind those same mistakes. This article is a series of expansions and explorations of each bias.
Investor Behavioral Bias #1: Confirmation Bias
By definition, confirmation bias “occurs when people filter out potentially useful facts and opinions that don’t coincide with their preconceived notions.” (Investopedia) Translation: as much as investors want to evaluate and make investing decisions based on empirical investing data, our confirmation bias can influence our perspective towards what we want to be true, not just what the data shows to be true.
According to Seawright, what makes confirmation bias so dangerous is that it can lead investors to make an investing decision and then research data to support our preconceived conclusions. If an investor believes a portfolio company is doomed for bankruptcy, they may research for articles and investment data that only support that belief. In reality, such a belief may be inconclusive or even completely inaccurate, a farce fabricated by a competitor to gain greater market share.
Confirmation bias works its way beyond the individual investor into even financial advisor circles. During market turmoil, bullish investors and advisors will likely remain bullish while bearish investors and advisors will also likely remain the same. Forbes.com featured an article on Warren Buffett’s approach towards confirmation bias. Buffett shared his approach,
“Charles Darwin used to say that whenever he ran into something that contradicted a conclusion he cherished, he was obliged to write the new finding down within 30 minutes. Otherwise his mind would work to reject the discordant information, much as the body rejects transplants. Man’s naturalinclination is to cling to his beliefs, particularly if they are reinforced by recentexperience–a flaw in our makeup that bears on what happens during secularbull markets and e xtended period s of stagnation.” (Forbes.com, “How Warren Buffett Avoids Getting Trapped by Confirmation Bias”)
The most effective way to combat confirmation bias is to acknowledge at least confirmation bias may be influencing a particular investment decision. Another excellent investment practice is attempting to research and understand truly empirical data that may contrast our confirmation bias. Financial investing is best done with as dispassionate of a decision-making process as possible. Rather than selecting confirmation only data, seek to make an informed, rational investment with full knowledge of any presuppositions or biases at play.