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How Confirmation Bias Affects Our Decisions

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Feelings often get the best of us when it comes to investments. Many specialists are driven by greed and fear. They sell low, buy high and tend to base investments on past performance.

Confirmation bias is one of various psychological theories that describe investor behavior. It states a person is more inclined to seek out opinions and news confirming their own views. The information age means novice investors, and professionals alike, can easily justify their actions by finding the right evidence to support the own views.

Many things lead to confirmation bias. Search engines, social media networks, newspapers, websites and even the people we meet manipulate us. Our information is configured based on our historical behavior. So we tend to get just the information we are looking for. The result? Misleading popular sentiment as the bias aggregates across the market.

What can you do?

You need to be more self-aware of your own biases. This is particularly true when it comes to the consumption of financial media. Our decisions are informed by what we read, therefore we examine ways of filtering the flow of information.

1. Does it really affect you?

Don’t let short-term fluctuations influence your long-term goals. Reacting to everyday events may result in losses you may otherwise have avoided. In general, there shouldn’t be any reason for unit trust investors to react to day-to-day events. Similarly, good financial planners only adjust your portfolio as your long-term needs change. Some events however should set off a few alarm bells, such as the following:

  • There are significant changes at your investment management firm (e.g. an abrupt change in investment philosophy)
  • Fund specific news (e.g. changes to fee structures benchmarks)
  • Any law or policy changes that could affect investments (e.g. government changes the legal restrictions on retirement funds or endowments)
  • Significant shifts in industry or countries (e.g. for the niche investor: mining-specific unit trusts are affected by a change mining license laws)

Generally though, only consider changes to your investments if your personal circumstances or goals change.

2. You need a paradigm shift

Leaving your comfort zone can be hard. Break away from your old, safe opinions by actively seeking alternative views. This is called the ‘Team of Rivals’ approach. You can achieve a more holistic view of the situation by reading about and attempting to understand viewpoints different from your own.

3. Find the facts

Theoretically, all the opinions and news in the media should be built on facts. These facts can be tracked back to their source. The source material allows you to formulate your own opinion and question other interpretations. It gives you a deeper understanding of the data. Always act on facts and not on emotional impulses.

4. Be aware of orphan opinions and weasel words

Baseless claims are often delivered with words such as ‘probably’, ‘likely’, ‘almost all’, ‘virtually’ and ‘seems’. These statements are designed to instill confidence in a claim that has no basis in fact. These are known as weasel words.

Orphan opinions describes where referenced opinions are accompanied by “Experts say…”. Generally speaking the headline sells the paper, but any opinion worth listening to comes from a person willing to attach their name to it.

Becoming more critical of what you see, read and hear helps you make better decisions. This is why we only react after careful consideration.

Posted on October 26, 2016.

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