It's human nature to seek comfort in the familiar, but when it comes to investing, this seemingly innocent tendency can lead to poor outcomes.
This is known as confirmation bias, a cognitive pitfall that sees us favour information that bolsters our existing beliefs and dismiss what contradicts them.
Why do we fall prey to confirmation bias? At its core, it’s a psychological defence mechanism, protecting us from the mental discomfort of cognitive dissonance. It soothes us to have our views confirmed, maintaining a consistent understanding of our world. However, in investing, this psychological safety blanket can become a hazardous blind spot.
Confirmation bias can skew investment decisions, causing us to overvalue supportive information and turn a blind eye to potential warning signals. It’s like driving with the rear-view mirror as your only guide. An investor might remain fixated on a stock’s past performance, ignoring red flags about the company’s future prospects.
Take the lead up to the Global Financial Crisis of 2008 for example. Investors, holding steadfast to their belief in ever-rising property prices, dismissed ominous signs of an overheated housing market, which was eventually followed by a disastrous fallout.
But it’s not all doom and gloom; confirmation bias can be tamed. Awareness is the first step – by acknowledging this bias, we’re already halfway towards combating it. It’s about embracing a mindful approach to investing, continuously challenging our assumptions, and actively seeking information that may contradict our views.
Furthermore, adopting a process-driven, evidence-based approach to investment decisions can counterbalance the influence of confirmation bias. By committing to a strategy that prioritises rigorous, objective analysis over individual hunches, we can make more balanced investment choices.
Unchecked, confirmation bias, can steer investors off course. By recognising and proactively addressing this bias, we can ensure it doesn’t cloud our investment journey, leading us towards more consistent decisions and reliable outcomes.
