18 Apr This Cognitive Bias Can Derail Your Investment Plan
A made up mind is a very hard thing to change. This isn’t entirely due to humans being stubborn, however – studies have found that once you’ve formed an opinion, you subconsciously embrace any information that confirms your view, while ignoring information that casts doubt on it. In fact, one study with over 8,000 participants discovered that you’re twice as likely to seek out corroborating data, while ignoring the rest.
Psychologists call this mental glitch the confirmation bias, and it can prove to be very dangerous in investing.
How can this cognitive bias affect your investment plan?
Investing is just as much an emotional game as it is a financial one. As Warren Buffett once said, “If you cannot control your emotions, you cannot control your money.”
Let’s look at one scenario where your inability to correctly filter information could lead to irrational investing decisions:
Say you form an opinion that a stock or investment will go up in the near-future, and you’re tempted to invest in it. Thanks to this cognitive bias, once you start looking into this investment, you’re only pay attention to short-term data supporting your decision, while ignoring your long-term goals as a result.
This bias is so dangerous because it can also lead to overconfidence. The more data and information you find on your opinion, the more you believe you’re right – even though you’re likely only getting one side of the story.
How can you avoid confirmation bias?
The best defense against this cognitive bias is a well-laid out long-term investment plan. When your emotions tempt you to make a knee-jerk reaction to the markets, you’ll likely find slim slices of data “supporting” that idea. For example, if a stock has gone up in the last three days, you’ll use that data to support your concentrated bet, while ignoring the market’s long-term performance.
A long-term plan, however, essentially forces you to look at the whole picture, because it takes a holistic look at your overall goals and needs in light of academic research, rather than paying attention to market volatility or media maudlin.
Learn more about how to avoid this cognitive bias in investing
At LexION Capital, we take a long-term view of the markets, and every investment decision made on your behalf is grounded by Nobel Prize winning research and backed by the math and science of the markets. To learn more about how we can help you stay rational in investing, start a conversation today.