Confirmation bias in economics refers to how we search for and interpret financial information. More specifically, people tend to disregard or ignore information that is contrary to their current beliefs. Instead, they look for information that confirms their beliefs. Stated another way, we are biased towards information that will confirm our beliefs.
Rather than researching and analyzing different data, we often reach conclusions first. It is faster and less work. Then, we gather facts and interpret them in such a way that it supports our conclusions.
For example, confirmation bias can arise when gathering information on a stock that you already own. If you own the stock, you probably already have an optimistic outlook for the company. Would you regularly read articles or research with negative information about the company? If you did, would you take it seriously or would you be inclined to discount it? Most people will actively avoid new information or spin negative research as inconsequential. Over time, as one continues to accumulate positive information and discount negative information, the investment decision becomes based on emotion cultivated by a positive echo chamber. Ultimately, confirmation bias can lead an investor to be overly optimistic about their investments and unaware of potential risks. Ideally, an investor would employ critical thinking and logic to evaluate the ongoing suitability of an investment.
Avoiding confirmation bias
- Make the best argument you can against the investment (i.e. devil's advocate).
- Imagine worst case scenarios for investments or the portfolio. Zeroing in on weaknesses can help an investor keep an open mind to alternate information.
- Commit to reviewing both positive and negative information with an open mind.
This is not a recommendation and is not intended to be taken as a recommendation. This material was prepared for general distribution and is not directed to a specific individual.
LPWM LLC does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisers.