Confirmation bias is the natural human tendency to seek specific supportive sources, or overemphasize information confirming our decisions. People will often come to a conclusion, then seek information confirming the decision. Think about buying a car, once you bought the car your brain starts to highlight all the other similar cars on the road. Surely we are not conceited enough to think “there are more of this make and model because I bought the car” and yet your brain helps to draw it into our registry.
It might seem backwards, but the seeking alpha and motley fools of the world know this and generate searches and lists confirming your already held conclusions. Confirmation bias can lead investors to be overconfident in an outcome, and as a result over allocate to a position and under hedge a risk. The investment consequences of this confirmation bias may also couple easily with some of the other biases we have discussed, most easily anchoring, endowment, and loss aversion. These “price point biases” are only entrenched when an investor seeks out other support for their price point.
Here is a great example of this in action:
Open a fresh google search and type in “is (insert company name) stock a”, and stop. Now look at the results, it will likely say “buy”, “good buy”, “good time to buy”, this is a feedback loop Google knows searchers want. Notice the lack of objectivity in the results? Our brains work similarly. We have a conclusion, then seek the supporting evidence to justify it. This overconfidence can result in a false sense that the decision is correct, and risk is not being properly rewarded. Which increases the likelihood of a misstep.
A series of psychological experiments have confirmed that in our decision making process, we expel contrarian view points early and to the detriment of rational. We carry a tendency to test ideas in a one-sided way, focusing on one possibility and ignoring alternatives. Explanations for how our brain alters the observed includes wishful thinking and the limited human capacity to process a high volume of conflicting information.
Another explanation, and one that might be more insidious, is that confirmation bias helps protect us (at least our ego) from the costs of being wrong. Rather than investigating in a balanced, objective, and scientific way our brains protect us early from the possibility of having made a mistake through confirmation bias.
This is an obvious investment bias. Being overly critical of criticism, and overweighting the value of consensus is not unique to investing. It happens with all of our strongly held beliefs. But investing carries the permanent impairment of wealth. I’ve even heard investors say, “this is why I get a diverse range of opinions, and use several brokers.” That doesn’t solve the bias however. It isn’t the range of options, or the volume of ideas you are evaluating. Recall that Google result was broad, and deep in its sourcing. But it’s the way the brain fabricates a positive or negative weighting as it processes that information that is the root of the bias.