Confirmation bias is the tendency to pick information, which aligns with our beliefs. When two people having diverse opinions read the same report but draw different conclusions from it based on their beliefs, its confirmation bias at play.
A good example of confirmation bias is when an investor researches about a stock after he has formed a positive opinion about it. In this case, he is likely to read articles, which validate his point of view.
Let us look at another example of two people having opposing views on climate change. When both read an article saying that temperature has increased by x% every year since industrialisation, there could be diametrically opposite conclusions drawn from it - the climate change believer will interpret it as a validation of his belief that we are close to the break point for earth and we need to halt this temperature increase. On the other hand, a non-believer may point out that the earth has been through many such cycles of rise and fall in temperature and point out that the period under review of 100 to 150 years is inconsequential compared to the billion years for which earth has been around.
Just like all other biases, it can affect your investments if left unchecked. This is because confirmation bias skews your view as it causes you to ignore contradicting data. It makes difficult for you to objectively analyse and interpret data, which may lead to wrong investments.
You may have come across many clients who are prey to this bias. Here are a few tips on helping them overcome this bias.
Make a list of pros and cons
In case of confirmation bias, awareness is the first step in helping the client understand that the bias is clouding his judgement. You can explain this bias to him and ask him to do a simple exercise before making any decision. Say he wants to invest in index funds instead of active funds. He is likely to focus on only the data, which supports investments in passive funds. Just ask him to do a quick research on why active funds are better. While this may not change his mind, it will help him understand that there is another perspective. Making a quick list of pros and cons will help him get a more balanced view about his investments.
Change search keywords
Most of us do our research on google. Google’s algorithms have a habit of populating articles similar to your past searches. Say you searched for song by a famous singer. The next time you open your browser YouTube will start suggesting other songs by the singer. This happens even when you are browsing net to gather data to make decision rather than idly browsing YouTube videos. Continuing from the past example, if your client searches for ‘why should one invest in passive funds’, he will get articles/data supporting his belief that passive funds are a better investment option. In addition, every time he opens the browser he will be bombarded with similar information. This will further strengthen his belief. An easy way to prevent this from happening is changing keywords. Instead of searching about ‘why should one invest in passive funds’ ask him to search for the ‘pros and cons of investing in passive funds’ or ‘active v/s passive funds’. Having neutral search words will help him see both sides of the coin. This will help him make better investment decisions.
