December 9, 2014

How do we know when our assumptions and beliefs are true, and not just wishful thinking? Think about that. Do you believe that the U.S. government is massively in debt, to the point where it’s almost guaranteed that our economy will crash and burn?

Do you believe that the Tea Party Republicans in the House of Representatives are going to force another government shutdown, triggering another stock market crash next year? Do you believe that climate change is a massive liberal hoax, and that the science about global warming is “unsettled?”

It turns out that it doesn’t take much to convince us that our beliefs are true and accurate. Our minds are biased to find evidence that supports our beliefs. Psychologists call this “confirmation bias.”

The way it works is, we start with a theory, and then we find evidence to back up this theory. We don’t go out of our way to look for evidence that proves our theory wrong. Nobody wants to be proven wrong, right?

It almost seems like self-deception, but it’s really our brains searching for a way to end uncertainty. There are so many things we don’t know. Sometimes the knowledge just isn’t available yet. But many times, we’re looking for a short cut.

 

confirmation bias

If we can find some evidence that supports our theory, we can stop thinking about it. For instance, there are plenty of people trying to sell investors on “guaranteed” stock-picking strategies. They sound great in theory. To make them look even more attractive, the inventors of these strategies present evidence that makes them look like can’t-lose propositions.

But in most cases, the “evidence” is cherry picked. We rationalize their story, telling ourselves we can ignore the supposed outliers and that it really does work … most of the time. As a result, we latch on to the good stuff and run with it. We barely stop to think before signing up to learn more about their amazing stock-picking strategy, all for three easy payments of $39.99. After all, it’s guaranteed.

Ultimately, confirmation bias is about telling ourselves a good story. I don’t blame people at all for preferring the story they’ve managed to tell themselves. But if we’re at all serious about making smarter decisions, we need to practice storytelling less and playing devil’s advocate more.

Source: Carl Richards, The Behavior Gap

About the author 

Erik Conley

Former head of equity trading, Northern Trust Bank, Chicago. Teacher, trainer, mentor, market historian, and perpetual student of all things related to the stock market and excellence in investing.

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