What is... | March 22, 2012

What is hindsight bias?

If information sent a company’s share price on a plunge downwards, we might look back later and see signs it was poised to fall. It feels as if we knew it all along.


With rises in house prices, election results and other occurrences, in hindsight the outcome can seem obvious. After the fact it can feel as if we always knew market shifts were coming or a certain party would win power.

If we don’t watch out, we can pass our “hindsight bias” , as it’s known among behavioural economists, to friends and family if we offer them tips based on our perceived financial successes and failures.

Look out when you look back
This bias can be dangerous for the way people manage money. Hindsight bias can skew our view of reality and encourage a view of the world as more predictable than it actually is. This can lead us to underestimate uncertainty – an important factor when making investment choices – and feed overconfidence in our ability to make correct decisions.

Some say hindsight bias can also limit what we learn from past mistakes as it distorts the memory of what actually happened. It can lead investors to underestimate the likelihood of occurrences that might have happened but didn’t, such as buying a house at a less fortuitous time and seeing the price fall instead of rise. Because of this failure to recall past decisions accurately, there can be a tendency to repeat past mistakes.

Relatives who prosper may look back and inadvertently believe this was due to a series of deliberate choices on their part whereas, in truth, luck and general economic conditions favoured them. The issue of the timing of property investments, referred to above, is an example of this. As an eZonomics poll on taking money advice from parents and grandparents warns, it’s possible to hand down hindsight bias to the next generation – highlighting the importance of seeking a wide range of sources of financial wisdom.

It’s so obvious now
For investing and trading, this bias can play on newcomers as well as the more experienced, studies show. Academics Bruno Biais and Martin Weber tested students and investment bankers and found a degree of hindsight bias among both groups. Interestingly, the duo found the highest paid bankers in their sample had the lowest incidence of hindsight bias.

Clearer view of the past?
While Biais and Weber did not find more experience or more precise information reduced the bias, other studies suggest knowledge may help. In the 1980s, US researchers examined 122 studies about hindsight bias, what they described as one of the most frequently cited judgement biases. They found certain situations could triple hindsight bias but in other circumstances there was only a small effect.

Having a broad knowledge and understanding of a company’s shares, the housing market or elections could help prevent a “one-eyed” bias forming. Thinking about how different outcomes could have occurred may help reduce hindsight bias and overconfidence. University of Bath management science academic Paul Goodwin also writes that working hard to gain knowledge may help reduce the feeling that you “knew it all along”.

InvestingFamilyBias

eZonomics team
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