What is... | April 20, 2012

What is confirmation bias?

Perhaps you’re going to invest in a long-term deposit at a bank. All of a sudden, the newspaper money pages seem full of opinions backing your choice.

 In reality, it might be that nothing much has changed in the wider world but you’re looking for information that agrees with what you want to hear. Instead of reaching an unbiased conclusion from surveying all evidence, this “confirmation bias” instead builds a case to justify your view. This selective thinking has many implications for investing – and for other areas of life.

Looking for the wins (but glossing over the losses)
Many areas of life are susceptible to this thinking trap, with research papers detailing circumstances relating to medical diagnoses, solving computer programming problems and more.

Likewise, many types of investments can be touched by this type of selective thinking – as investors seek information that confirms views such as a share rally is about to end, a currency will rise or gold is set to fall . Even when looking to invest in a business, the bias might lead us to look for recent financial “wins” while we conveniently look past “losses”.

It sometimes teams up with other thinking traps, such as the availability bias that can make more recent or vivid information play a greater role in decisions than is warranted. Despite the prevalence of the confirmation bias, fewer than half of respondents to an eZonomics poll knew its meaning.

Should I buy my dream home?
In a guest blog post for ING Direct USA’s We, the Savers, eZonomics wrote how property buyers are susceptible to the trap.

Buyers might selectively interpret house price statistics to back up their decision to buy – perhaps believing a view that property in their area is set to rise but not seeking out wage to house price figures showing homes there are overvalued. Because emotions play a role in house buying, the pull to justify buying a dream property can sometimes be too much.

Look for information that contradicts expectations
The prevalence of financial scams – “too-good-to-be-true” promises of quick wealth – demonstrates “people sometimes demand very little in the way of compelling evidence to drive them to a conclusion that they would like to accept”, wrote academic Raymond Nickerson.

Nickerson wrote that recognising the existence of confirmation bias – and the many situations in which it can occur – might help combat it. Such a step may make people more cautious about quickly making up their mind on an important issue and encourage them to seek out contrasting views.

When assessing real estate, for example, it might pay to try to view the purchase through the fresh eyes of a disinterested observer. Call those friends who you know will challenge you on your decision – see if your conviction can withstand the pushback. For all investing and large spending decisions, fully research the market. Look for information that contradicts your expectations.

InvestingEmotionBiasSharesHouse buyingCash

eZonomics team
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