The next cognitive biases we'll look at are known as self-attribution bias and hindsight bias. Self-attribution bias refers to the tendency us humans have to attribute successful outcomes to our skill and unsuccessful results only to bad luck. Put another way: we choose to explain the cause of an outcome based on what makes us look best - the problem being that this prevents us from learning from our mistakes.
Investors who experience a run of successful results start to develop an inflated opinion of their skill, thus possibly resulting in both complacency and exaggerated risk-taking. And, of course, if one endures a terrible run in the market, by attributing this only to misfortune, how is one to learn from one’s mistakes successfully?
Take care not to fall into this trap. Try to learn from the unsuccessful outcomes, and when success comes your way, do not let overconfidence step in and prevent you from acquiring a realistic assessment of your talents.
Hindsight bias is another beast altogether. It is merely the tendency for us humans to view things that have already happened as having been both relatively inevitable and predictable.
So how does this relate to the world of investing? Well, who among us hasn’t at one time or another watched one of our stocks drop for some reason, and then gone on to lament that we can’t believe we didn’t see it coming – it was so obvious! But you see, the problem is that it wasn’t so obvious. It may be now with the benefit of hindsight, but it was not at the time.
And once again, the problem with mistakenly believing that the occurrence was both inevitable and predictable is that we aren’t able to learn from the experience adequately. It is essential to learn from your errors, rather than to attribute your mistake to your inability to notice something at the time that was supposedly so very noticeable. The truth is that it was never obvious, and your mistake was likely more than merely an oversight.
A recent example of hindsight bias that has plagued me relates to the current market darling Afterpay (APT). During the COVID crisis that saw markets tumble earlier this year, I bought some shares at around $12. As they retreated further to about $9, I did what I thought any prudent investor would do – I cut my losses and recognised that far bigger stocks than APT had vanished during market crises.
Of course, with the stock now at $133, a small but nagging part of my brain can’t help but say I should have known it was simply market panic and I shouldn’t have let that get to me. I should have seen the eventual recovery in stock price and held. But of course, that’s easy to say now with the benefit of hindsight. Had APT gone into liquidation, I would probably be patting myself on the back for my genius and foresight (self-attribution bias). And even had I held it, I probably would have sold at around $20 (or less) once I had roughly doubled my money. The odds of me still holding at $133 are beyond slim. Nothing about the stock’s share price movement in 2020 was obvious or predictable at the time, so forget what hindsight bias is telling you now.
It seems that whatever happens, one falls prey either to self-attribution bias or hindsight bias (or both) unless of course one becomes aware of these biases and decides not to buy into their trickery. Keep an investment journal, document the reasons behind your investment decisions, and analyse the outcomes without your sensibility being hijacked by these natural human biases.
