BookWatch: Here’s how you can fight confirmation bias and become a better investor
If you want to become a better investor, you have to look beyond simply the facts and figures—things like portfolio allocation, risk analysis, due diligence. To avoid making the most common investment mistakes, you must do the much harder, yet exceedingly valuable, work that comes from looking inward.
Behavioral psychologists have long talked about the dangers of emotional investing: cashing out of the stock market when prices begin to fall only to return after they’ve gone up again, for example, or limiting your perspective and worldview to those who agree with you, also known as confirmation bias.
Unfortunately, most of us seek out sources that reinforce our worldview, whether about politics, investing or something else, and avoid or devalue information that conflicts with these beliefs. We consult the best voices on our own side and assign the opposing side to the most fringe figures.
Only a relative few have the courage to actively seek out opposing views that challenge their ideas and then, even occasionally, change their minds. You should aim to be one of them.
Confirmation bias is one of the biggest errors investors make. If you’re passionate about Tesla
and its stock, you may go out of your way to cherry pick news and information that supports your thesis while also believing that everything Elon Musk says and does is brilliant. Or you may think Musk is a megalomanic and use every outlandish statement he makes as a reason to steer clear of the stock, despite the attributes of the company.
Investment managers like Cathie Wood, the high-profile CEO of ARK Investment Management
are increasingly viewed as rock stars to some while those on the other side are equally convinced that she’s on a lucky streak and that her funds will collapse in no time. Whatever your position, you won’t have a hard time finding information that supports your view.
We also see this with cryptocurrencies
where investors tend to divide into two camps: crypto proponents who believe the value of these tokens will continue to skyrocket and skeptics who seize on every downturn as evidence that cryptocurrency is a dying fad.
We all think we are right—and not just about some things but about everything.
One way to fight against this urge is to think about a stock you like. Then, instead of poring over news that reaffirms your belief, find the strongest voices on the other side and see if what they’re saying makes any sense. Even Warren Buffett admits that he falls prey to confirmation bias and therefore actively seeks out other investors who disagree staunchly with his ideas.
Next, consider everything that can go wrong. Imagine, in 10 years, that you’ve lost a substantial amount of money. How could this have happened; what are the various scenarios? Force yourself to consider all the possibilities.
For example, you can make the case that bond yields
are so low that it makes no sense to own any at all. But what could go wrong? Well, lots of things. There could be a bear market that takes down stocks, real estate, hard assets and many alternatives all at the same time. The Federal Reserve’s pullback could put us back in a slow-growth, borderline deflationary environment or, like many countries, interest rates could go negative.
Under all those scenarios, bond buyer could look very smart.
Investing deals with primordial emotions like fear and greed. While we may not be able to make these emotions go away entirely, we’re not helpless. We can recognize and oppose these limiting beliefs, which will help enrich our lives, not just materially, but emotionally and spiritually as well.
Peter Mallouk is president and CEO of Creative Planning, an independent wealth management company with $90 billion in assets under management, and the author of “The 5 Mistakes Every Investor Makes and How to Avoid Them.”
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