Hindsight bias is the tendency to believe, after the fact, that an event was predictable or obvious, even when it wasn't.
This psychological quirk arises from our brain’s desire for certainty and order. It helps us make sense of the world around us and aids our learning process. But when it comes to investing, hindsight bias can trip us up.
Hindsight bias can foster overconfidence, as investors convince themselves they ‘knew’ an outcome would occur. This can lead to riskier investment decisions, under the belief that they can accurately predict future market movements. Hindsight bias can also cause investors to misremember their past investment choices, leading to skewed perceptions of their investing prowess.
Consider the rise of sustainable investments or “green investing” in recent years. After witnessing its success, some investors may claim they “knew” this trend would prevail. In reality, many were uncertain or even sceptical about its potential. This illusion of having predicted the trend may embolden them to make overconfident forecasts in the future. Additionally, being accurately able to predict what might happen in the future, and getting the timing correct are two separate issues. For example, fund managers who recognised the Dot Com bubble in the late-90’s and avoiding overvalued stocks were eventually proved correct, however, missing the final melt-up over several years cost them significant amounts of redemptions, with many funds ultimately closing as a result, only to be proven correct.
Maintaining a detailed investment journal can also be beneficial. By recording investment decisions, and the rationale behind them, at the time they are made, investors can have an accurate record to refer back to, preventing them from rewriting their investment history.
Hindsight may be 20/20, but it doesn’t predict the future. By recognising and managing hindsight bias, Aussie investors can approach their investment decisions with a clearer, more realistic view.
