If you looked around your social circle, how many of the same – or similar – opinions do you hold with others in the group? What about the people you follow or are connected with on social media? Or think about the news stations you tune into every day: do the stories they report validate or challenge your worldviews?
A little self-reflection may reveal a common struggle, a cognitive error known as confirmation bias. Simply put, confirmation bias is when we seek out information or individuals who support our position while ignoring the ones with opposing viewpoints. Whether the topic is religion, politics, or money, we tend to gravitate toward the media and peer groups who confirm how we feel, what we value, and what we believe – and away from those who contradict our closely held beliefs.
Confirmation Bias in Investing
Confirmation bias can even influence how investors build and manage their portfolios. For example, maybe you’ve invested in a specific stock because you feel an affinity or alignment with the brand. Unfortunately, the stock has consistently underperformed, providing lackluster (or even negative) returns time after time. Yet you continue to stick with the stock, simply because you appreciate the company’s mission.
While your investments and values should be aligned, confirmation biasmay prevent you fromrealizing the underperforming stock isn’t helping you reach your financial goals. That’s because confirmation bias often causes us to make decisions with our heart, not with our head. Sometimes it can even lead investors to not only pick not-quite-right assets but hold on to them way too long. For example, consider two cosmetics companies. Company #1 is a smaller organization with a poor return on investment, while Company #2 is a prominent name brand with a positive return. Based on that information alone, most investors would probably pick Company #2 for their portfolios.
However, the decision-making process isn’t always that straightforward. Company #1 might have lackluster returns – but they have vowed never to test on animals while Company #2 has not made that pledge. This information may persuade an animal advocate to avoid the bigger company and instead invest in the company with animal-friendly testing policies. Unfortunately, while investing in Company #1 aligns with the investor’s values, its poor performance may not match with the investor’s financial goals.
Investing Outside the Echo Chamber
Our confirmation bias can also influence who we choose to do business with, particularly when it comes to selecting a financial advisor. Some investors choose an advisor who confirms their pre-existing beliefs instead of taking the time to explain the full picture. For instance, Jill is an investor who recently started working with an advisor. When the market dropped, she told her advisor she wanted to move all her investments to cash. When her advisor explained why that decision might not be the best for her long-term financial plan, Jill moved her money to another advisor who told her what she wanted to hear, even if the advice didn’t match her overall financial goals.
Jill was practicing selective exposure, choosing to consume only the information that matched what she already perceived as true. Unfortunately, selective exposure often creates an echo chamber where current viewpoints can’t be challenged or new ideas introduced. The danger of the echo chamber in investing is that you aren’t gaining objective feedback. And without objective reasoning and guidance, an investor may miss out on crucial details and information to make smart and sustainable investing decisions.
Of course, no one enjoys being in a situation where their viewpoints are challenged. We all want to be around like-minded individuals who validate what we believe. However, objectivity is essential for making hard decisions, especially those related to investing. Looking at all the options through an impartial lens can help ensure that our decisions are logical and planned, while considering both the cost and reward. By becoming more aware of how confirmation biases drive our cognitive and emotional tendencies, we all may be more open to receiving valuable insights into why and how we invest the way we do.
At Moran Wealth Management®, we provide objective guidance and advice to help our clients make the most informed financial decisions possible. We understand how investment psychology and market philosophy work together, and we use that knowledge to deliver a fresh perspective to our clients. To set up a complimentary consultation with one of our financial advisors, call us at (239) 920-4440 or visit our website at moranwm.com.
This blog article contains general information that is not suitable for everyone and was prepared for informational purposes only. Nothing contained herein should be construed as investment advice. Moran Wealth Management®, LLC (“MWM”) is a Registered Investment Adviser. The information contained herein is based upon certain assumptions, theories, and principles that do not completely or accurately reflect any one client’s situation or a while exposition of the topic. All opinions or views reflect the judgment of the author(s) as well as of the publication date and are subject to change without notice. For additional information about MWM, including its services and fees, request the firm’s disclosure brochure using the contact information herein or visit advisorinfo.sec.gov.