Why Confirmation Bias in Finance is Bad for Investment and How to Control it
Emotion can sometimes lead to counter-productive investor behaviour, such as confirmation bias and commitment confirmation bias. For example, when investors get greedy or fearful, they might buy high and sell low and sometimes use past performance to guide their decisions.
This behaviour is not based on rational thought but rather a psychological reaction, causing them to lean towards those opinions or the news that reaffirms their own views and theories. Using this, they then justify their actions.
Understanding Confirmation Bias in the Finance Industry
One of the biggest culprits influencing investor behaviour is confirmation bias. It can sway our decision making in all spheres of our lives, one of which is investments. On the other hand, commitment confirmation bias is the tendency to want to be consistent with what you’ve done in the past.
In a world where wide-ranging information is at our fingertips, it can be easy to find information to support our opinion and a need to stay consistent, but how is it affecting investors?
How Confirmation Bias Affects Investors
We’re influenced by our peers, websites we visit, news we consume, etc. Everything we encounter daily influences our decisions. Furthermore, advertisers take advantage of this by tailored, targeted ads based on our daily habits and historical behaviour.
How to Control Confirmation Bias in Finance
To manage our own confirmation biases, we must first be aware of our tendency to resort to them. Secondly, we have to find a way to filter through it to avoid it.
1. Think About The Big Picture
Try to think about the bigger picture, not just how you feel and think today. When you buy and sell, you have to focus on the long-term and not just everyday biases and events. When it comes to investing, you should focus more on reacting to a change in your circumstances than daily events broadcast on the news.
Besides, if you have an expert fund manager on your side, they will take all of this into account. Or, if you have an independent financial advisor, they will bring your portfolio up to speed accordingly.
When it comes to listening to the news, there are only a couple of events that you should consider when it comes to investments. For example, changes at the specific investment management company or funds you’re investing in or government laws and regulations potentially affecting your current investments.
2. Widen Your Net of Influence
It’s essential to not only seek out news that confirms your opinions or beliefs. Avoid this kind of confirmation bias by actively reading and trying to understand different viewpoints. Known as the “team of rivals’ approach, it can help give you a clearer and more rational perspective.
Pay Attention to the Words
There are subtle ways that the media can influence your opinion and play on your confirmation bias. Pay attention to words like ‘probably’, ‘almost all’, ‘seems’, etc., which can make you think it’s true, although it might not be factual and rather general statements.
Also, be especially careful when you read phrases such as “experts say” or “studies suggest”. Unless you can pinpoint and trace it back to a trusted source, you should not take it as truth.
4. Don’t Believe Everything
Because we have so much information at our fingertips, we sometimes forget that not all of it is factually correct. Do your research to ensure everything you’re using to guide your decisions can be traced to a trusted source.
Don’t Get Fooled by Your Own Confirmation Bias in Finance
Always ensure that you use an authorised financial services provider to help you make the best investment decisions for you.