Whether we believe it or not, human beings are not rational at all times. A lot of pre-conceived notions /opinions play on our mind while taking any decision. We always try to search for evidence to prove our intuitions/opinions. In short, this is what is called confirmation bias.
Confirmation bias is the tendency to search for, interpret, favor, and recall information in a way that confirms one’s pre-existing beliefs or hypotheses.
The 2-4-6 experiment that was developed by Peter Wason was one of the experiments that proved that humans suffered from this bias trying to support their own theory, instead of completely and rationally evaluating their theory.
The participants were told that these numbers conform with a certain rule, and the experimenter had a certain rule in mind that was true in case of three sets of numbers, and to find examples that adhere to this rule. The experimenter had a very simple rule in mind: numbers in ascending order. However, the participants took complicated theories and did not test whether the theory is false for these numbers.
Thus, when you formulate hypotheses, you look for clues that confirm it, rather than find information that will criticize it. Thus, when a researcher formulates an opinion, instead of critically evaluating it, he will be in the pursuit of finding theories that support it.
In real life we have many examples where unknowingly we fall prey to the confirmation bias, such examples are :
- Many of us who are Cricket fans have this belief that if Sachin Tendulkar hits a century, India will lose the match. Because of this belief, we end up searching for a past history of such matches lost and form a hypothesis.
- We have been for ages hearing Cancer as a deadly disease and end up believing it that it is not curable and survival is very low. This belief is so strong that we end up finding failure cases rather than checking for advanced improvement in medical facilities which has helped many patients survive cancer.
- Celebrities such as Ratan Tata, Mahatma Gandhi, Mother Teresa, Sachin Tendulkar, Big B, Rajnikant, Barack Obama are left-handers. Most of us do end up believing that all the successful celebrities are left-handers.
- A low carb diet helps to lose weight. If this is what is on your mind, everywhere your mind will end up finding evidence to prove this theory.
There are many such real-life examples, where confirmation bias plays a role in our perceptions and decisions. Now, how does this confirmation bias affect our investment decisions?
- Online websites, print media, etc keep publishing performances of various mutual funds and promote few mutual funds in the name of returns. This information creates a bias towards a fund and we all intuitively hunt for information to support the information and start investing.
- Similarly, in the case of bear phase / falling market phase, there is a lot of information about negativity or issues with the various investment products. Intuitively again we hunt for the information to establish evidence to it.
This is one of the reason, why many investors have not made returns while on paper Sensex had delivered returns in the long run. The philosophy of Buy low, Sell High didn’t happen because, confirmation bias pushed us to do the opposite i.e, Buy High, Sell Low.
How do we protect ourselves from such biases overpowering our investment decisions?
The only way out / solution to stay away from this bias is as follows :
- Establish & write down your financial goals
- Create an asset allocation plan and stick to it
- Every time a piece of news/information hits you, find out both sides of the information and rationally evaluate if that information affects your financial goal. If yes, take a decision else stick to your asset allocation
Remember in the long run, only patience, asset allocation and disciplined investing help you reach your financial goals.
Unfortunately, we all have confirmation bias. Even if you believe you are very open-minded and only observe the facts before coming to conclusions, it’s very likely that some bias will shape your opinion in the end. It’s very difficult to combat this natural tendency.
If we know about confirmation bias and accept the fact that it does exist, we can make an effort to recognize it by working to be curious about opposing views and really listening to what others have to say and why. This can help us better see issues and beliefs from another perspective, though we still need to be very conscious of wading past our confirmation bias.
Happy Investing !!
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