The Dangers of Confirmation Bias
Be Aware Of - And Avoid - Confirmation Bias
It’s human nature to gravitate towards people, events and beliefs that are like our own. Confirmation bias is the tendency to seek information that supports what we already believe and ignore information that contradicts these beliefs. We find that confirmation bias operates in many areas of our lives today. How we spend our leisure time, what media we consume, who we spend time with, and even how we decide to digest financial news and information. Today it seems like more and more people tend to exhibit confirmation bias. This can be explained by the increasing amount of information we have to process, and the way we consume it. Today’s technology and media outlets are becoming extremely focused on trying to figure out what we want, and then give us more and more exposure to it. Thus, creating echo chambers that amplify and reinforce what we already believe. They make it easy for all of us to “scratch the confirmation bias itch”. For personal and emotionally charged issues, the effects of this phenomenon are even stronger.
As for the investment world, confirmation bias is noticeable and widespread. With so many different information sources available, we must all choose where to gather our information. But is everyone publishing data both fair and balanced? Are there alternative motives? Both investors and investment managers can exhibit bias in three ways. Next time you watch CNBC or read an investment article, keep an eye out for these.
Bias In Research: Bias in research refers to an individual being one-sided when searching for information that supports what the person already believes. Instead of looking for all relevant data, the person asks questions in a way that reflects their preferences. Subsequently, yielding answers that support their hypotheses. An example of this could be someone that believes interest rates will soon drop, and only seeks data to support their search. They ignore relevant data that does not support their thesis.
Bias in Interpretation: Confirmation bias can also occur in the interpretation of information. When this happens, the individual interprets the data with bias. For instance, if a piece of information proves or supports their existing beliefs, they tend to favor this evidence. On the other hand, information that challenges or opposes their preconceived notions may be disregarded or criticized.
Bias in Memory Recall: Memory can be affected by confirmation bias. People tend to forget evidence contradicting their beliefs and recall the details that support their biases. This reminds me of the neighbor that only talks about their big winning investments and can’t seem to remember any of their failures.
The legendary investor Warren Buffett once said:
“What the human being is best at doing is interpreting all new information so that their prior conclusions remain intact.”— Warren Buffett
Knowing of these biases makes it logical to infer that confirmation bias will most certainly lead to a less diversified portfolio. Similarly, you can also expect over concentration in your confirmed areas of bias. This leads investors to make decisions based on incomplete information, which in turn can lead to lessor outcomes. As people and investors, what can we do about confirmation bias?
Awareness: The most important thing we can do as investors is to acknowledge confirmation bias exists and be aware that it impacts all of us. As you begin to consume data, think about confirmation bias. How do you react differently to information you agree and disagree with? Failing to recognize your own biases is itself a bias. Nobel Prize-winning physicist Richard Feynman noted that, “The first principle is that you must not fool yourself — and you are the easiest person to fool.” Be ready to assess yourself and recognize bias when it appears.
Diversification: As mentioned above, it’s logical to assume that a portfolio that has been exposed to confirmation bias has too much of something (s) and not enough of others. Using a disciplined approach with specific allocation targets helps avoid misallocations, timing mistakes and unforeseen surprises.
Focus on Goals / Not Noise: Having a portfolio that is built around a goal helps you focus away from the bias to what’s most important, the achievement of the goal. Goals are also a good point to focus on because they have timeframes associated with them. Chasing short term performance to achieve a long-term goal rarely pays off and is a mismatch between the goal and the investment. By shifting focus towards the goal and away from the noise of individual investments can help embrace proper diversification.
Data Source Awareness: Where is your data coming from? Always consider the source. Is it just raw data, or does it come with personal opinions? Every month we get a chance to see inflation and interest rate data. The data tends to speak for itself. What gets more interesting is how people try to read the tea leaves. Be aware of your data sources and understand the data is usually pretty good. It’s the personal opinions wrapped around the data that can harbor hidden biases.
Let’s Talk! At Filigree, we welcome conversations with clients and friends about their portfolios, goals and maybe even a bias or two. Building portfolios around goals helps us focus on what’s most important. We also use collaborative technology to better communicate, leading to more focus around goals and client success. When we can avoid the noise and focus on goals, we remove the weeds of confirmation bias from our thinking. Never be afraid to challenge yourself and your thinking. Better yet, let Filigree Wealth Advisors have those conversations with you!
Filigree Wealth Advisors
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