A 2009 study found people are twice as likely to seek information that confirms their beliefs than to seek evidence that discounts them. Peter Watson first proved this with his selection-task study in the 1960s.
As choices are guided by our thought process, it can be a very costly mistake. Especially when money is on the line. (Read our free special report The Bank of You and learn why you should invest in P2P loans in 2017.)
How Confirmation Bias Broke Gold Bulls in 2011
Under the spell of this bias, the more you learn, the more certain you become that you are right. We don’t know it at the time, but biased research paints an incomplete picture of the situation. A 2015 survey by the CFA Institute found confirmation bias commonly influenced investor judgment and led to poor investment choices.
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A look at the actions of gold-bulls over the past decade is a good example.
In the three years after the 2008 financial crisis, gold rose over 60%. Pointing to the economic and monetary follies of the period, gold bulls believed the yellow metal would continue to climb and invested accordingly.
Since its 2011 peak, gold has fallen by 35%. During its decline, bearish signs like a strong US Dollar were ignored. Instead, they focused on the reasons why gold had entered a new bull market. They later paid the price.
This bias has been observed in other investors. A 2010 study found that investors strongly preferred ideas that matched their own on internet stock message boards. When investors had a ‘’strong-buy’’ view of a stock, they were 8-times more likely to click on bullish posts about it.
The study concluded that the most biased investors became over confident in their beliefs due to confirmations. In the end, when an investor’s bias increased by 1 standard deviation, it led to excessive trading and decreased returns by over 9%.
With a myriad of online investment information, having biases is easier than ever. Whatever your views, you can connect with others who share them. This can lead to an echo-chamber like environment for investors.
When things are going well, there is no problem. But when investors hit a rough-patch, they may have no clue why their picks are tanking. Investors are likely to repeat this mistake time and time again.
If bias intrudes on our decision process, how can we manage the risks it poses?
Warren Buffet’s Approach to Decision Bias