Have you ever felt unsure about a purchase or personal matter and sought validation from someone you know who shares your perspective? We all do. It’s called confirmation bias. It’s when we actively seek out, interpret and retain information that aligns with our beliefs. It makes us feel better. Seeking approval from like-minded people can help you make decisions, but it can also create blind spots. When you only focus on what you know or believe, you risk missing contradictory information that could negatively (or positively) impact your portfolio. Confirmation bias has also been known to cause some investors to become obsessed with a few companies or investment types. When this happens, your portfolio could become less diversified, which could mean you’re exposing yourself to too much risk – or too little – depending on your investment needs and goals.
What is Confirmation Bias?
Confirmation bias is the tendency to favour information that corroborates pre-existing beliefs or theories. In our view, confirmation bias can lead to significant errors in investing. Investors may develop an inflated sense of certainty when they encounter consistent evidence supporting their choices. This overconfidence can create an illusion of infallibility, with an expectation that nothing can go wrong. To counteract confirmation bias in investing, we proactively question established norms and actively seek out data to question our investment hypotheses. Our approach involves a constant ‘inversion’ of the investment argument to understand potential flaws in our reasoning. We make it a point to reassess our investment rationale, particularly in light of emerging data, and to rigorously test our presuppositions.
Understanding Confirmation Bias
Of all the biases mentioned, confirmation bias is the most well-known because it’s the most widespread throughout society. Essentially, people tend to unconsciously look for information or evidence that supports their existing beliefs about something and reject data that contradicts it. If you believe women mostly drive blue cars, your brain will pay closer attention to, and look for, blue cars driven by women. This doesn’t necessarily mean your belief is accurate, however.
Conclusion
Confirmation bias can be challenging to overcome, but knowing it exists is half the battle. Examine your investment portfolio with an open mind and have a willingness to look for and accept new information. Search out evidence that challenges or contradicts your investment thesis and take the time to compare what you know with what you don’t know.
