The Hidden Dangers of Confirmation Bias in Investing
“You’re right because your facts are right and your reasoning is right – and that’s the only thing that makes you right.” – Warren Buffett
Anyone who has had a discussion (or argument) about an opposing viewpoint knows that a made up mind is a very hard thing to change.
While this phenomenon can be incredibly frustrating, our tenacity to be stubborn isn’t entirely a conscious effort. Once you’ve formed an opinion, your mind is hardwired to embrace any information that confirms that view, while ignoring or rejecting information that casts doubt on it.
In fact, a recent psychological study with nearly 8,000 participants concluded that we are twice as likely to seek information that confirms what we already believe as we are to consider opposing evidence.
Psychologists call this mental glitch the confirmation bias. When it comes to investing, this bias can prove to be very dangerous.
When your emotions tempt you to make a knee-jerk reaction to the markets, you’ll be strongly inclined to notice opinions and slim slices of data affirming your decision, and ignore your long-term plan as a result.
Take the global financial crisis, for instance. Your instincts would have been screaming at you to sell your equities when the stock market lost nearly half its value between 2007 and 2009.
If you had $100,000 in the stock market, you would have seen your stock portfolio plummet to a value of $54,381 by February 2009. Thanks largely to this mental bias; you’d be strongly inclined to ignore your long-term goals, and to instead focus on this plummeting short-term performance.
However, we now know that the best course would have been to ignore those instincts. If you had remained in the stock market in 2009, your portfolio would not only have recovered; it would’ve soared from $54,381 to $172,425 over the next 70 months.
The lesson here for investors: Our minds can make short-term reactions seem like the best course of action, but they usually lead to the opposite of financial success.
When you listen to your instincts and pay attention to short-term market noise, you’ll feel a great need to react in investing. However, it is the careful, panned back view that can best serve your long-term goals. Prudent investors tune out market noise and stay the rational course.
At LexION Alpha, we attempt to remove biases from the investing equation. Our investment strategies are firmly grounded in data and focused on long-term results.