If you’re a savvy investor, then you most definitely do your research before you invest in a fund – or do you? Do you know whether you are taking in all possible sources of information and acting accordingly? Confirmation bias is a psychological phenomenon which can lead us in the wrong direction and hinders us when it comes to being fully informed.
This bias refers to a phenomenon where people tend to live in their own bubble – essentially, they tend to look for information that merely confirms their own opinions and avoid taking in anything that goes against what they believe to be true. Because of this tendency, people miss the bigger picture and don’t make fully informed choices. It can happen in every aspect of your life, from the books you read to the news sources that you use.
This bias has been demonstrated many times in a scientific setting. One study which has produced interesting results was performed by Park, Bin Gu, Kumar and Raghunathan and entitled Confimation Bias, Overconfidence, and Investment Performance: Evidence from Stock Message Boards. The researchers performed a study of investors who sought out information about potential investments on message boards in South Korea.
They analysed the responses of 502 message board users and found that investors tended to exhibit this bias when they processed information on the message boards, as they use this information to confirm their previously held beliefs. What’s more, these biased investors showed a lot more confidence in their investments, tended to trade more frequently and also tended to achieve poorer returns. This study is just one example of how a person can be lead down one path and have a poor holistic view of the situation.
Here’s a real world example of confirmation bias in action. An investor hears a rumour that a company’s stock is about to soar, as they are about to launch a successful new product. He then goes online to do some research and tends to pay attention to the stories about the up and coming product and all the press releases about how great it is. There are news stories, however, about how poorly the company has been performing or how overhyped the product is, but because these articles go against what the investor has come to believe, he simply ignores it.
So how can you avoid falling into this trap? Here’s a quick list of things you can do:
- Don’t try to prove yourself right: Make sure you’re searching for open ended information, not just the information that will confirm your suspicions.
- Use different news sources: Make sure you use different media sources and even different media like books, newspapers and the internet.
- Look for both sides of the picture: Even if you think a counter argument may be ludicrous, it doesn’t hurt to look for a contrarian view to ensure you know the pros and cons.
Can you think of any other ways you can avoid confirmation bias? Let us know in the comments!