In his latest Wall Street Journal column, Jason Zweig discusses one of the behavioral pitfalls that can drag down many investors’ portfolios: confirmation bias.
What is confirmation bias? “In short,” Zweig explains, “your own mind acts like a compulsive yes-man who echoes whatever you want to believe. … A recent analysis of psychological studies with nearly 8,000 participants concluded that people are twice as likely to seek information that confirms what they already believe as they are to consider evidence that would challenge those beliefs.”
Scott Lilienfeld, an Emory University psychologist Zweig interviewed, says part of confirmation bias involves assessing past decisions. “We’re very good at cooking up post-hoc explanations of why our predictions didn’t work,” Lilienfeld says. “We reinterpret our failures as near-misses: ‘This stock would have gone up if only X had happened,’ or ’99 times out of 100 I would have been right if not for this freak event.'”
The more you research, the more information you thus find to support your beliefs, Zweig says. “Each new fact makes you more inclined to find another fact that resembles it, reducing the diversity and value of your information,” he writes.
Zweig offers a number of suggestions for how investors can overcome confirmation bias. A few examples:
- Look out into the future and imagine that the investment you’re considering goes bust. Then try to come up with the best reasons this might happen;
- Before making your investment, determine what you think are the odds that it will not work out. This way, you’ll be prepared for the possibility of failure, and won’t be as likely to “dig in your analytical heels and desperately try to prove that you are still right” if it does go bad;
- Before investing, write down a list of things that could occur that would change your opinion of the investment.