This article originally published in The Northern Daily Leader on 30 March 2013.
A few years ago I put myself through some terrible self-induced torture. I paid for a year’s subscription to a political magazine which was completely opposite to my political views. Each month the magazine would arrive in the mail and I would force myself to sit down and read it from cover to cover. The trouble would start soon after I finished reading the contents page. Within minutes I would be arguing with the magazine, disagreeing with nearly every word. Of course I had to share my frustration and would track down Liz and try and engage her in a conversation about the unbelievable things I was reading in the magazine. I thought I was calmly pointing out the flaws in their arguments, though Liz was less kind and called it my monthly rant.
The purpose of this monthly ritual was not to give myself a heart attack, though sometimes it felt that way. The real purpose was to challenge my thinking; to confront the way I viewed the world and try to understand why other people saw it differently. Just because I held a particular opinion didn’t mean that opposing views weren’t valid. Although in this instance I was challenging my political view of the world, the same principle can be applied to investing. One of the most common behavioural biases encountered in finance is that of confirmation bias. This is just a fancy way of saying that we are prone to seeking out those opinions which confirm our already established view of the world. Most of us are guilty of this, whether it’s just watching a particular TV channel or only reading a specific newspaper. For example, if you believe that the global financial system is on the verge of collapse, you’re probably most comfortable reading the ‘Gloom, Boom and Doom Report’, or spending time on internet forums full of survivalists discussing bunkers, weapons and how to make your own canned food.
Confirmation bias is a leading cause of investor over-confidence, where we become convinced that our investing judgement is the right one. Just like the study which found that 93% of American drivers said they were better than the average driver; clearly an impossible outcome. The trick to defeating confirmation bias, and its unwelcome friend over-confidence, is to make a conscious effort to challenge your thinking. If you’re bearish on the future of the market, spend some time reviewing the optimistic material published by those who are bullish and try to figure out why they feel that way. And do the same but in reverse if you think the market does nothing but goes up. But when you do, do as I do and keep one of those foam bricks handy – it may well save you the cost of a new TV.