Have you ever looked back at an unexpected event, really thought about it and figured you could have predicted what was going to happen based on what was occurring just before it? Sounds like the pretty logical way to look at things because you can learn from the past and figure out what indicators to look for in the future, but the funny thing is that this form of remembering and reflecting can actually have a profound effect in how we make decisions and could lead to overconfidence, one major pitfall when it comes to investing.
The phenomenon where you believe that an event is more predictable than it actually is is called Hindsight Bias, and it is basically psychology’s way of saying you are a Know It All. This term refers to when you believe that you can read a situation and predict an event from that analysis, even though you pretty much cannot. Basically, it seems that it is a common human phenomenon to be completely wrong and super lucky, but also confidently delusional at the same time.
So what are some real world examples of hindsight bias in action? One really simple relatable example (especially if you live in England) is predicting the weather. One morning you look outside to see grey clouds (again, great example for England) and say to yourself, “I would bet my last penny that it will be raining by lunch.” Sure enough, lunchtime rolls around and you are singing in the rain like Gene Kelly because it feels so gosh darn good to be right. But you better slow down with that dance number, because the big question is: how did you really know it was going to rain? Sure, you were looking at the signs (which could have been pretty good indicators) but it was just as likely that it was not going to rain. So stop fooling about, smartypants.
So how does hindsight bias present itself in the investment world? Investopedia has a great article giving a couple of prominent examples. Financial bubbles are often interwoven with hindsight bias – people will look back and try to nitpick events and points which were “predictors” of what was to come. The problem with this is that they were not necessarily predictors and if they were, people would have twigged before the event occurred.
On a more personal level, hindsight bias can occur when you are buying and selling stocks and shares. For example, you sell your WhyFinance shares and moments after the share value skyrockets. Then you think to yourself, “I should have held on to them, it’s obvious that they were going to skyrocket, the blog’s amazing and the articles are just so informative.” It is one thing to look back, but was this information so obvious at the time you made the sale? It probably wasn’t; you were just making the best possible decision you could make with the information that you had at the time.
Alternatively, you may have held on to your WhyFinance shares thinking, “This blog is so awesome, it is only going to go up,” and then it does. And this causes you to believe that you could correctly read the signs and predict which way the value of the shares would go. The problem with this is that the signs you were reading and the result may not even be related and you just got lucky – this could lead to you being overconfident in your abilities and making a big mistake further on.
So what can we learn from this? Firstly, it is that we should trust ourselves; we are only doing the best we possibly can (at the time). Secondly, we need to remember that second guessing is not going to help anyone; the only thing you can do is learn from the past and not repeat those mistakes. Lastly, if you are feeling extremely confident in yourself after having a good run with investments, make sure you keep a level head! No one can be right all the time, so you need to ensure that you keep looking at traditional indicators of performance and try to keep an informed holistic view before you make a decision.