Imagine you turn up for work and you’re feeling a bit sensitive. For no particular reason, you believe all your colleagues are performing better than you. You fear you may not be selected for the next important project. Your boss then unexpectedly suggests you have lunch together.
What goes through your mind at that point? If it’s, “my boss wants to talk to me about my poor performance,” that’s confirmation bias.
In this scenario, you have ignored any positives and looked for and focused only on the negatives. Your boss wants to see you, so it must be bad news – confirmation that you aren’t performing.
But it’s just as likely that they just wanted to catch up with you or even share some good news. Perhaps you have been selected to lead the big project, after all!
Finding the facts to suit your theory
While filtering out the facts that you don’t like may not always have significant consequences, when it comes to investing it could be very bad news.
Suppose you are reviewing your long-term asset allocation – that is, how much you hold in shares, how much in bonds, and so on. You’ve been thinking for a while that markets are looking expensive. So you’re minded to lock in some profits. You start doing your research and only read the stories that confirm your view. You write off the other articles as being written by inexperienced analysts or having invalid arguments. As a result, you reduce your risk.
This may or may not play out in your favour. But the point is, you haven’t based your decision on all the facts. You’ve been selective in order to get the result that you wanted – the one that will make you feel better in the short run but will not necessarily make you better off in the long run.
Confirmation bias isn’t just a problem for individual investors. Even professional fund managers can fall victim to it by recruiting similar-minded people to work with them. So when it comes to investment decisions, there may be a tendency for them to agree with each other rather than seek out dissenting voices and analysing what the real truth may be.
How to combat confirmation bias
The next time you think about your investments, check with yourself that you have done a full appraisal of all the facts.
- Make it a point to seek out at least one differing point of view before any important decision and consider their arguments with an open mind.
- Be aware of the changing circumstances. Your assessment may have been right at one point but there’s always new information to consider.
Doing all this will not guarantee your investment success, but it will give you a better chance of it.
Investment risk information
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Issued by Vanguard Asset Management Limited, which is authorised and regulated in the UK by the Financial Conduct Authority.
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